Barry Norris shares eight important investment rules that will help you survive the crisis.
We are under house arrest. We are all now Prisoners of the Pandemic, Inaction Heroes, told to stay at home. Prisoners entering jail for the first time are told to “know a bit of slang”, “share a cell with the right person” and “brace yourself for re-entry”.
Airmen shot down behind enemy lines are told that their fate is “usually settled in the first few hours after ditching” and that “survival depends on two vitally important factors: morale and knowledge”. Commandoes in the desert are given two pieces of advice: “know your enemy” and “decide a plan of action”. We are now at war, and our financial, as well as physical survival, is at stake.
Know your enemy
Sun-Tzu wrote in The Art of War: “If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle.” This is also true of successful investing.
What do we know of our enemy? We know relatively little about the virus except that it originated in the Chinese city of Wuhan, and we have seen nothing like it since the Spanish Flu of 1918. But we do know that its economic consequences have been profound and extremely hazardous to most financial assets. We can expect three main phases of conflict:
Phase One: Blitzkrieg
There is panic liquidation on the realisation that the economy is going into (self-isolation induced) recession. There is a dash-for-cash mentality: an indiscriminate selling of all assets in a desperate search for liquidity. Even gold, suffers its biggest one-week fall on record. Leverage among investors exacerbates chaos. We will need to go back to 1929 for a faster sell-off in equity markets.
Phase Two: Resistance
Following unprecedented stimulus from central banks and governments (surpassing even 2008 efforts) asset prices will in aggregate begin to stabilise. In equity markets, there is some attempt to differentiate between winners and losers from the crisis.
The scale of the short-term economic devastation becomes apparent. Moral plunges. Investment commentators will agree that there will be no V-shaped victory this time. There is widespread disgust with equities and its overpaid “beta jockey” fund managers.
Companies begin to fail, often those unconnected to the crisis. Stocks that have been deceits are unmasked. We will see many a swindle and fraud before this bear market is out.
Phase Three: Counter-attack
Infection numbers peak and markets begin to anticipate a normalisation of economic activity. Investor confidence returns. Risky assets recover, but some are fundamentally impaired and can never regain past glories. There is little participation or enthusiasm in the populace for victory given capital destruction and loss of risk appetite.
According to Sun-Tzu, “the general who wins a battle makes many calculations in his temple before the battle is fought”. And it is also true for the successful investor in how they approach the threats and opportunities of this crisis. Our stock market survival manual contains eight important investment rules that will help you survive the crisis:
1) Stay diversified in all things
There will be widespread seemingly irrational panic sales as a result of the initial Blitzkrieg. Many professional investors face being encircled by the pincer movement of illiquid assets and a liquid investor base. Being sufficiently diversified mitigates this potential early knock-out blow.
2) Be selectively opportunistic
Sun-Tzu says, “in the midst of chaos, there is also opportunity” and in the rush for the exits there will be high-quality assets sold for knock-down prices. Wellington described this more coarsely as “picking the pockets of the dead on the battlefield”.
3) Keep discipline in the ranks
Keep your emotions in check. You need to think rationally and survive with your wealth intact. Force yourself to sell stocks only when they are up and buy them when they are down, unless you are already hopelessly out of position.
4) Stay liquid
Maintain liquidity even as the conflict progresses. Memories of the collateral damage caused by the initial dash-for-cash mean that the market will price in a longer-term liquidity premium on all asset classes. Capital markets with depth will therefore stabilise first and then lead the recovery.
Think at least one step ahead of your enemy. Your tactics will need to evolve over the conflict. Don’t just think about the obvious losers, but also the second-order negative effects that the market has not yet begun to price.
6) Keep an open mind
Do not become dogmatic in your thinking. Try to prepare for all eventualities, even those no one is yet talking about, however unlikely they seem. For instance, will the virus just go away in warm weather? Have we all already been infected, displayed no symptoms, never been tested and survived? Be sceptical of expert medical opinion when it comes to investment decisions.
7) Stay patient
Elvis once sang “only fools rush in” and it’s as important in bear markets as in love. Do not be fooled into thinking that initial counter-attacks will lead to a quick knock-out victory. Exercise caution in ugly, distressed and illiquid situations.
8) Keep up morale
Philosopher Thomas Hobbes once wrote that life in society without a state was “nasty, brutish and short”. It is normally also true of bear markets. Avoid the temptation to become more depressed about the future the further the market falls. It is only a matter of time before the enemy will be defeated. There will likely be some fantastic opportunities ahead, but only for those who have preserved their capital, and able to enjoy the spoils of victory.
Barry Norris is manager of the FP Argonaut Absolute Return Fund.