Force Majeure: The Investment Conundrum
Force Majeure: The Investment Conundrum
All you attorney clients should be geeking out with this blog, as I use some industry lingo. For you non-attorneys, what is force majeure? In legal contracts, it is usually a clause written that simply removes one’s liability for unforeseeable and unavoidable catastrophes that interrupt the normal course of events or liabilities from happening. For instance, if in 2019 you signed a contract to be done building your house by the end of 2020 with a contractor, and something like a global pandemic shows up, a force majeure clause would potentially kick in absolving the builder from certain penalties for not being done on time.
So what? What does this have to do with investing? In a weird way everything as it is a great way of understanding when markets have a quick change in direction. You see, I’ve often written about the thing markets hate the most, uncertainty. I’ve also heard people suggest we should have a crystal ball and be able to anticipate everything. Impossible!
The reality is our job, on the investment front, is to take an abundance of data and formulate long-term positionings to take advantage of said data. The issue everyone faces, albeit easy to play Monday morning quarterback, is when the data is either flawed, unknown or quickly changes. Let me give you two very recent and good examples.
Force Majeure Example 1:
Covid is a great first example, to be honest. We went into the year with good financials and low unemployment. Then we started hearing about this “flu-like” disease called Covid. Most of us didn’t think too much about it at first. Next thing you know a global pandemic ensued, extremely quickly, and the markets had the quickest bear market ever recorded. Force Majeure! No one could have realistically planned, prepared, expected, or even if so had a realistic way to craft a solid investment strategy to combat it. Candidly, the best approach and still is to ride it through making adjustments as data kept presenting itself.
Force Majeure Example 2:
This is a good one and even more current. I’ve heard people on both sides of the fence saying last year’s hyperinflationary environment should have been easily predicted. In hindsight, I totally get this principle. However, let me transport everyone back to the 3rd/4th quarter of 2021. Inflation was creeping up in the 5-6% range. Most economists were calling it transitory, meaning non-permanent. Furthermore, what did the Federal Reserve (which is made up of seven of the most intelligent economists and financial minds on the planet) have to say? The Fed went into 2022 not only saying they believed inflation was transitory but also suggesting they planned to raise rates 3 times in 2022 for a total of .75%. Instead, the Fed ended up raising rates 7 times for a total of 4.75%. That is drastically different then what they set out to do. Force Majeure!
In both examples, you can see how force majeure played an integral role. Even going back to the 2008 housing crisis. This stemmed from everyone assuming mortgage-backed securities, including all rating companies, were conservative great investments. Then one day we woke up and realized they were terrible along with being massively misrepresented.
These are the reasons we often see quick directional changes in the stock market. They are easy to look back and say duh, as we learn more about them in hindsight. However, in the moment there is generally that one moment that completely blindsides everyone leaving a big element of unpredictability. This inevitably leads to a complete repricing of assets, and expectations, along with investors having to adjust accordingly.
Good Investment Strategy
At the end of the day, how does a good investment strategy combat force majeure? I can speak from watching our investment team do their work. Their job is not to predict the future. However, what I see them doing is first crafting a strict investment philosophy that is repeatable and dynamic. Next, they are constantly analyzing thousands of pieces of data to formulate a plan of attack. Then they research how realistically to make adjustments using historical information to best combat this new set of data. Finally, they act swiftly to implement these changes to take advantage of the new reality.
Until the next force majeure stay wealthy, healthy, and happy.
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