Adjusting To A New Risk-Reward Spectrum

Adjusting To A New Risk-Reward Spectrum

In the early days following the arrival of the COVID-19 pandemic on our shores and the ensuing social and economic lockdown, the economy went into a tailspin.
The stock market plunged more than 30% in March, wiping out trillions of dollars of wealth, unemployment skyrocketed and the GDP dropped like no other time in our history.
The U.S. government responded with a $2 trillion bailout, but relief has been temporary.
Unemployment remains high and GDP is still stagnant as the pandemic rages on with no vaccine available yet to combat its devastating social and economic effects.
This all brings us to investment risk.
We are living through strange economic times – the likes of which have never been experienced in our history. The typical investment risk-reward spectrum has been completely upended because of the unique economic circumstances of this pandemic-induced economic downturn and the unreliability of many economic models.   
There are many reasons for not relying on traditional economic models and forecasts. For one, the data is completely unreliable at the moment. Wall Street is the prime example.
There is no underlying economic rationale for Wall Street to be trading near its previous record high before the pandemic. Yet, on August 28th, the Dow closed just 3% off its record high on February 12. Unemployment is still high, corporate profits are still stagnant.
So, what’s going on?
Trading activity on Wall Street has been feverish and the pandemic has been the unintentional cause of this frenzy. It seems the pandemic has fueled a small investor boom. Millions of Millennials, bored from COVID-19-induced quarantine and watching their incomes shrink are giving the stock market a try for the first time to boost their economic fortunes.
These Millennials and stay-at-home investors are a different breed of investor. It seems this breed of investors not only doesn’t care whether they win or lose but relishes in amassing losses – many even boasting of their losses on social media.
With easy and convenient mobile transactions along with commission-free trading platforms like Robinhood, it has never been easier to play the market – virtually rolling the dice with no clear strategy or goals in place.
This breed of investor ignores economic fundamentals – snapping up penny stocks and even stocks of companies who have filed for bankruptcy like they’re going out of fashion.
The problem with this new trading frenzy and rampant speculation in the stock market is overvalued and bound for a correction, with millions of investors bound to lose billions soon.
Want proof that the stock market is overvalued?
Warren Buffett thinks it’s overvalued and is even cashing out billions of Berkshire Hathaway’s (his public investment company) stock holdings. In other words, he’s sidelining his cash.
Why does Warren Buffett think the stock market is overvalued? According to his favorite market indicator, it’s time to get out of the stock market.
The indicator Warren Buffet relies on most to gauge stock market value takes the combined market capitalizations of publicly traded stocks worldwide and divides it by global gross domestic product. Markets Insider explains, “A reading of more than 100% suggests that the global stock market is overvalued relative to the world economy.”
This indicator has recently soared towards an all-time high, for both the U.S. and the world. This indicator isn’t the only reason Buffett’s sitting out the stock market.
Buffett doesn’t trust traditional market forecasting and risk-reward analysis in today’s economic environment.
In the early days of the pandemic, Warren Buffett owned more than $4 billion in airline stocks with stakes in United, American, Southwest, and Delta Air Lines. He vowed he would never relinquish his airline stocks – pandemic or no pandemic – because the models told him airline stocks were still a good investment.
In May, Buffett had to eat his words when he unloaded ALL his airline stock. Even the greatest investor of our time has been befuddled by the new economy. Even Warren Buffett doesn’t trust the modeling.
All the uncertainty, unpredictability, and unreliability of today’s market has led to historic volatility in the markets. In this crazy new world, where does an investor turn with the stakes even higher now than before the pandemic?
Investing with money that you may never need like before the pandemic vs. investing with money you may need in two years completely changes the game.
So where to turn with market turmoil and so much at stake?
Take unpredictability out of the equation. That’s what the smart money (ultra-wealthy individuals and deep pocket family offices and institutions) are doing. They don’t care about the reliability of market models and the risk-reward spectrum because they’re allocating away from the public markets.
The smart money has two overriding objectives informing their investment decisions that are different from the Main Street investor:

  • Preserving Income.
  • Avoiding Wall Street Correlation and Volatility.

Savvy investors don’t want to depend on their jobs for income and don’t want to leave their economic fates to the whims of Wall Street.
That’s why they turn away from Wall Street towards alternative assets – particularly assets that produce consistent cash flow backed by tangible assets that can never be wiped out completely. These twin benefits are not found on Wall Street.

  • How do you adjust to the new economy?
  • How do you adjust to a distorted investment risk-reward spectrum?
  • How do you adjust to unreliable market data models?

Take Unpredictability Out Of The Equation!
Turn Away From The Public Markets Towards The Private Markets
The new economy is giving investors suffering from the devastation of COVID-19 the opportunity to avoid disasters in the future by reallocating to assets immune from market unpredictability, volatility, and unreliability.
Look to alternative asset classes that not only preserve income and capital but thrive in the new economic landscape.

About The Author

John Turley


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