Risky business: caution needed amid markets uncertainty

Berkshire Hathaway CEO Warren Buffett — with vice chairman Charlie Munger — is among the great investors ‘now sounding the alarm’. Picture: AFP

As the world grapples with COVID-19 and the worst economic downtown since the Great Depression, stockmarkets hit all-time highs. These conflicting outcomes are cause for both contemplation and caution.

Warren Buffet reminds us that “risk comes from not knowing what you’re doing”. This message has never been so important.

Nobody knows what is going to happen next.

There is simply no precedent to the major events playing out across the world. There is so much uncertainty that quantifying the collective impact on financial markets is impossible. In the last 12 months alone, we have experienced devastating bushfires, the ongoing COVID-19 pandemic, an oil price war, the ‘‘Black Lives Matter’’ protests, a global recession, record unemployment, unequalled monetary and fiscal policy, and extreme volatility in currency, debt and equity markets. Uncertainty is at a peak.

And an uncertain world is the worst possible environment for financial investment. It becomes very difficult, if not impossible, to quantify risk.

Yet recently we have witnessed widespread risk taking by those unaware of the danger of uncertainty. This is occurring with ever increasing vigour as financial markets move away from fundamentals.

In the last three months alone, I have had countless people ask me “how to buy shares”. I have heard of “financial advisers’’ advocating superannuation withdrawal so clients can “start trading” (on margin!).

And I have had numerous people ask me if they should buy Tesla, Afterpay or Amazon shares as “valuation does not matter in today’s globalised world”.

Not one of these people have mentioned price, valuation or risk. In many cases, they don’t even know the stock code to purchase the security. I don’t write this to criticise; I write this to provide insight into how the market is accounting for risk. And today, it frequently isn’t. As a result, volatility and unpredictably has drastically increased.

In March, due to COVID-19, we experienced the fastest and deepest stockmarket fall in history, greater than 40 per cent.

This was followed by an aggressive recovery as over $US20 trillion was committed to combat the virus’s economic impact.

Never before have governments acted so quickly to provide support to the global economy. This fact, coupled with a decade of declining interest rates, has elevated sovereign, corporate and personal debt to extreme levels.

The world has not experienced a confluence of events like these; the impact on our economic system has never been tested.

Ric Kayne famously said that “95 per cent of all financial history happens within two standard deviations of normal, and everything interesting happens outside of two standard deviations”. We are now operating many standard deviations away from normal, and strange things are happening.

• Global markets hit all-time highs as unemployment skyrockets and businesses face widespread insolvency. The Nasdaq is now 10 per cent above its pre-COVID-19 levels and the Chinese market 12 per cent above.

• Government bond yields have turned negative: -0.5 per cent per annum in Switzerland. This is not supposed to happen. Society is literally paying banks to hold their money.

• The US Federal Reserve is buying junk bonds (the debt of failing companies) for the first time in history.

• Hertz, a company in bankruptcy, has people wanting to buy $1bn worth of its stock.

• Tesla is now worth more than Toyota.

• Internet day traders blindly pick stocks from scrabble bags and amass millions of followers.

• Online trading platforms promote and gamify day trading. The Robinhood platform, for example, utilises falling confetti to celebrate each new buy transaction.

These events are not normal.

The greatest investors of our time are now sounding the alarm, yet many of us are not listening. Warren Buffet holds more than $US130bn in cash reserves and continues to highlight the importance of holding cash in a crisis.

Jeremy Grantham of investment giant GMO believes we may be experiencing the “fourth major stockmarket bubble” in his 40-plus year career.

And Howard Marks of Oaktree Capital talks of significant global uncertainty in his 2020 memos and questions the current sharemarket ­recovery.

These investing greats are not calling the next bear market, nor another decade-long bull run. They know better than to forecast the madness of markets. Rather, they counsel the need for caution given vast and complex global uncertainty.

Australians should heed this advice and realise that financial markets today are no place for widespread speculation.

The eloquent wisdom of Charlie Munger is well suited to our current age.

He reminds us that “nobody knows what’s going to happen”.

So perhaps we should all stop trying to predict the unpredictable.

These are uncertain times and extraordinary markets.

Michael Skinner is a portfolio manager at Renaissance Asset Management. He also lectures in finance and engineering for the University of NSW and is a honours supervisor at the University of Adelaide.