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Investing in the face of a disaster

Photo of Lars Kroijer

This guest article is by friend of Monevator and former hedge fund manager Lars Kroijer, who is also the author of Investing Demystified.

The emergence of the coronavirus over the past two months has dominated the news and preoccupied the markets.

The virus is already having a real impact all over the world, as millions curtail travel and social interactions, and suffer financial or – worst of all – great personal loss.

At the time of writing, more than 4,000 people have died globally. The great worry is this number could increase dramatically as the virus continues to spread.

Stock markets plummeted again on Monday before rebounding on Tuesday – and of course nobody can know where they will go next. The expected future risk of the markets have spiked recently, too.

For as long as there continues to be huge unknowns about the path and severity of the virus and its economic consequences, uncertainty will continue to reign.

What – if anything – should we do about all this from an investing perspective?

Getting a VIX on things

In previous posts on Monevator I’ve argued it’s highly unlikely you’re able to outperform the markets, or to find someone who can consistently do so for you.

The world may be in a panic state and markets have declined, but this is still overwhelmingly likely to be true.

Also, markets might be down and you may have lost money, but that doesn’t necessarily mean they will recover – no, markets don’t always bounce back.

The fact is that unless we have genius insights or a crystal ball, we almost certainly don’t know the future direction of the markets or even individual securities.

So what do we know?

We know that the world is now deemed to be a far riskier place for equity investors.

While not a perfect or long-term index, the VIX (a measure of predicted future risk of the equity markets) has increased from an expected standard deviation of under 15% to around 50% at the time of writing1.

This is important because it is the world telling you that your equity holdings are a lot riskier going forward than they were a month ago – though that’s perhaps an obvious point!

With this higher risk, it is not unreasonable to have a higher future expected return from shares from here, but then again the market is also telling you that very bad outcomes have become far more likely, too. Whether that impacts how you should adjust your portfolio really depends on your risk preferences and personal circumstances.

There is also every chance that your other assets – house, job, career prospects, and so on – have been impacted by the virus, perhaps indirectly, though you may not know it yet. This hit to your wider economic life will likely be far more muddled than simply saying you lost 20% in your equity holdings but your government bond holdings did quite well.

If you’re unclear about the potential impact and you have an advisor with insight into your overall financial situation, I would recommend a conversation. Focus especially on the liquidity of your assets and liabilities, and the likely increase in the correlation of the value of your various assets.

Prep school

I don’t have any kind of unique perspective into what will happen with the virus or its impact on the global economy.

But as the volatility index is suggesting, it does seem obvious that the risk of a very bad state of the world has increased dramatically as the virus has spread across the globe.

So I think it makes sense plan accordingly.

In my book Investing Demystified I wrote a chapter called ‘Apocalypse Finance’ about what we should do at such times from an investing perspective, depending on the severity of the financial collapse. We’ve tweaked and republished this chapter below.

While things have obviously changed since it was written four years ago – and it doesn’t discuss any specific kind of disaster, let alone a pandemic – I hope you’ll find some useful insights.

Apocalypse investing

Let’s consider the highly unlikely. Some would say paranoid. How bad can things really get and what might happen to our investments in a worst case scenario?

We obviously don’t know, but I think it is important to discuss how our investments would fare when all our plans are out the window and the world has gone haywire.

Not long before the financial crash of 2008, a book called The Black Swan2 by Nassim Nicholas Taleb was published. It caused quite a stir in the financial community.

The title of the book refers to an age-old assumption that all swans were white. Swans had always been white and it had almost become part of the definition of being a swan – that it is a beautiful, graceful, white bird. The swan-watching community (if there is such a thing) was therefore aghast and confused when a black swan appeared out of nowhere. Everything the community knew and had taken for granted was suddenly in doubt when such a fundamental assumption as the colour of a swan could be shattered in an instant.

Taleb uses this parable to make a mockery of common parameters of risk used in finance. He describes how if you assume the annual standard deviation of the S&P 500 is 15%, then a drop of 45% would represent a three standard deviation move. Without skew or fat tails3 this should happen approximately 0.14% of the time, or about every 700 years. In reality it seems to happen every couple of decades! I’m grossly simplifying, but I think Taleb would forgive me in the interests of getting a complex point across in a paragraph.

Where am I going with this? I think we need to occasionally think about what most of us consider highly unlikely and undesirable scenarios.

Previously I’ve written about the short-term government bonds of the most creditworthy governments in the world, and how there are probably no securities that are lower risk than those.

But what if we, for a moment, allowed for the possibility of a complete collapse of society, with governments going bust and law, order, and property rights all negated?

The unthinkable is unthinkable

It’s hard for most of us to imagine what this kind of complete breakdown looks like without knowing much more about the reasons why it happened.

For instance it struck me as odd when watching the movie Contagion (about a lethal virus) that even with 40 million people dead in the US and in a state of complete panic, the main characters still walked around in clean clothes and drove their cars.

Would there really be functioning general stores and petrol stations with the world in such a state? Would your credit card be working? Electricity and water? Could you get your money from the bank – and if you could would that money be worth anything?

I am going against the logic of Taleb’s book in even discussing how society’s breakdown could happen or its consequences. Taleb discusses the ‘known’ unknowns and the ‘unknown’ unknowns, and to my mind basically concludes that we don’t know squat, other than the fact that unlikely events are more likely to happen than we think.

By even discussing ways in which the highly unlikely may happen and its consequences, in Taleb’s mind I may be missing the whole point that the unknown is exactly that, and trying to forecast it is a doomed undertaking.4

Still, how we protect ourselves and our loved ones from an investing perspective if society breaks would depend slightly on how it happened.

Was the disaster due to a massive natural shock that we survived? Was it war? Was it an epidemic that wiped out half the world’s population over a couple of months of sci-fi style mayhem?

Gold as security

The ownership of gold in such a meltdown may make a lot of sense. Over the past centuries gold has served as a great bartering tool, whether held as gold bars or in the form of jewellery.

Thinking of gold as a good hedge for markets that are so desperate that your investment in assets such as AAA-government bonds is worthless suggests a state of almost complete collapse.

We all remember the horrible stories from World War II when people bartered gold or jewellery for things like food or shelter or the possibility of escape. People who have studied history and worry that it may indeed repeat itself may find that owning gold has some insurance value to them.

One point of caution on owning gold: suppose you get exposure to it by owning a gold-mining company or an exchange-traded fund (ETF) that tracks gold. The value of those assets would track the value of gold closely as the world heads towards turmoil. But would they actually be of value to you in the case of complete breakdown?

Maybe not. Depending on the exact disaster there may not even be a functioning stock exchange where you can sell your gold correlated securities. And the bank where you held the securities in custody might be a ruin.

Perhaps as a cautious investor you have some gold bars at a very conservative bank in a vault that could withstand ten atomic bombs or whatever disease the evil spirits have thrown our way. But again, the gold here may not be of use to us when we need it.

Would the bank actually be open for us to go and collect the gold? In such a desperate state of the world would we trust that the employees of that bank had not broken into the vaults and stolen the valuables if that meant feeding their children?

Even in the case where you were able to go to the bank and pick up your valuables, you may not want to. In a completely broken-down society, imagine what it would be like to walk out of a bank with a bunch of gold?

You’d undoubtedly glance nervously over your shoulder as you exited the bank and police protection may be non-existent.

If not gold, then what?

Obviously the scenarios I describe above are extremely unlikely. Major disasters of such magnitude have only happened a couple of times over the past century. Even in those cases it was not disaster everywhere in the world, simultaneously. Of course those caught up in the horrors of war or mayhem will find it scant comfort that things are better elsewhere; they are forced to deal with what is in front of them.

If you can’t realise the value of securities or even pick up valuables in a safety box at a bank then the breakdown of society as we know it today would be so complete that we individually would probably be worried about other things, such as shelter, security, food, and water. Probably the last thing on our minds would be how to best invest our assets. Indeed people with the paper version of this chapter would probably burn it for warmth, while mocking the memory of the orderly and stable society most investment books take for granted.

In certain circumstances, ancient jewellery has historically been a preserver of wealth in times of great distress. It is easy to store, hide, and transport. That said, as with gold I would caution you against storing lots of expensive jewellery at home: the risk of theft could quickly eliminate any benefit from holding it.

In certain cases property may be a good asset in times of extreme distress – even if it is illiquid for immediate use. Besides the possible benefit of it as arable land, if the crisis passes there may well come the day where the rule of law prevails and you can reclaim your assets. While shares in companies may be worthless with the companies long gone, property may maintain some value.

Finally, there is some protection through the holding of the broadly diversified portfolio. Although the scenarios discussed above are clear calamity scenarios, there is some chance that part of the portfolio will survive and maintain some value as a result.

Even in our highly interconnected world, a global tracker is geographically diversified. Holding securities in companies in diverse locations such as Australia, Brazil, Canada, Europe, the US, China, and Japan may be of some value if calamity strikes your London home base. For all the securities in such a portfolio to be rendered worthless a calamity would have to strike simultaneously all over the world.5

How could 2008 and 2009 have happened?

My point with the crazy stories above is that your best investments in times of great distress depend on how you define ‘great distress’.

If you define great distress as what happened in 2008, then a AAA-rated government bond is indeed a great preserver of value. In fact things could have gone a whole lot worse than what happened in 2008 and that would still be the case.

But although my suggestions of societal breakdown may seem alarmist or like scenes from a bad science fiction novel, if we’re talking about extreme ‘black swan’ events then conventional thinking is redundant.

I remember talking to a few friends at collapsing financial firms during October 2008 and again in March 2009 as they were navigating their way through the mayhem. One phrase I remember hearing a couple of times, mainly as a joke, was: “If this gets any worse, it’s guns and ammo time.”

While I chuckled back then, it was interesting and scary to see how fast the world could go into panic mode, even without a trigger like war, epidemics, or natural disasters. This was a panic caused by the falling house of cards that most of us had helped build through the creation, purchase, regulation, complicity, or ignorance of a crazy, headless, expansion of credit.6

As bad as things were at the worst point of the 2008–09 crisis, they could clearly have been much worse. There were still functioning financial markets, no governments had defaulted (they had in fact been able to oversee large and necessary bailouts), there was no hyperinflation or threats of war, and there was no widespread civil unrest.

Suppose that instead of the world recovering from the darkest days of the 2008–09 crisis, things had taken a turn for the worse.

We would probably have had a complete collapse of the financial system. Virtually no banks would be in business, or at least not be operating like we take for granted they do today. Your insurance policy would probably be worthless, with the underwriter bust. Many governments around the world would be unable to meet their short-term debt maturities and be in default. There would be nobody with liquidity to buy their debt.

With no functioning financial institutions, trade and commerce would completely dry up. Why would you deliver goods to store when there was no real way you could get paid? Similarly, petrol stations might not be working and public transport would be a mess. (An informed friend told me that the UK has about three months of food reserves and six weeks of fuel, assuming normal consumption patterns.)

Tax revenues would plummet further, as there would be far lower incomes to pay tax on and commerce would have come to a halt (so no sales tax or VAT). The absence of tax income and the inability to refinance short-term bonds would cause the government to cut back severely on spending, including benefits, pensions, education and medical care. Sensing what was in store though, the government might increase spending on police and the military. With the inability to fund itself the government might start issuing IOUs (promissory notes), but these could lose credibility quickly as it became apparent that the prospect of repayment was poor.

People who lost out to these major government cutbacks would probably be extremely agitated. Civil unrest might break out. We have seen cases of civil unrest (like the London riots) or larger protests at government spending cuts in relatively normal states of the world. But since the picture I’m painting is much worse, we can assume that even more widespread unrest could dominate. Where all this could lead is anyone’s guess, but probably nowhere good. The whole infrastructure of society would come under great stress.

The scenario I describe above probably won’t happen in my lifetime, the lifetime of my children, or even the grandchildren I hope to have one day. Or at least I hope it won’t! My point is to demonstrate that we must have a flexible mind when we consider all the possible outcomes in our investing lives.

The question is: how should we think about investments in a state of complete societal breakdown, not seen in my lifetime, at least in the Western world? These could include potential scenarios where property rights have broken down, there is no police or food on the shelves of the stores, and your money is worthless anyhow.

As I see it, a simple passive portfolio mixing a global tracker with your minimal risk asset – what I call a ‘rational portfolio’ – remains superior in virtually all states of the world, except in the scenario where the world is left without property rights and all investment assets across the world are worthless.

In a highly unscientific ranking of different levels of societal breakdown here are some thoughts on what you might want to own:

  • Depending on the level of breakdown, we could still be safe with AAA-government bonds (though they would probably not still be AAA anymore) – potentially from countries other than our own.
  • In slightly worse scenarios we would probably want to own fixed assets such as a house or property. There would still be value somewhere in the broadly diversified rational portfolio, as the whole world probably would not go bust all at once.
  • In an even worse scenario than this where property rights are out the window, we would probably want to own high-value yet easy to hide and transfer goods like gold or jewelry.
  • In complete mayhem we’d want shelter, security, food, and water. And indeed guns and ammo.

If you are inclined to think the worst is remotely possible then perhaps Google ‘preppers’ and explore the world of people who are actively preparing for the collapse of the world order as we know it. Personally I think they are paranoid and a bit crazy, but they would equally consider me naïve.

Finally, the emergence of virtual currencies/commodities like Bitcoin may someday provide additional financial shelter and be a potential alternative to gold. These cryptocurrencies are still in the nascent stages, but if they end up as a recognised asset that can be stored securely I wouldn’t be surprised to see their value go up at times of turmoil and stress in the financial markets. I would caution you to consider risk of being hacked though – particularly at times of lawlessness – and also to think about whether there would be enough ways for you to practically utilize your Bitcoins, either via payments for goods, or else to translate them into the fiat currency you’d need to spend.

Oh, and if you’re going to fill your cellar with tins of baked beans then don’t forget to also pack a tin opener!

Want to hear more from Lars? Read his posts or grab a copy of his book – Investing Demystified.

  1. 10 March 2020 []
  2. The Black Swan: The Impact of the Highly Improbable (Penguin, 2008) []
  3. i.e. Big moves that are more likely than suggested by a normal distribution. []
  4. Though paradoxically he also discusses buying government bonds and put options to protect against calamity, which both assume somewhat functioning financial markets to profit from the disasters. []
  5. Many companies in the world equity portfolio have large net cash holdings (Apple has over $200 billion in cash at the time of writing) unlike governments, which are typically large net debtors. In a really nasty world scenario those cash holdings might prove invaluable and ensure they survival longer than many governments! To ensure you actually own those underlying stocks you would want your ETF to be physical, as opposed to synthetic, where you take credit risk with the issuer. []
  6. I recommend reading How I Caused the Credit Crunch by Tetsuya Ishikawa (2009, Icon Books). Tets, who was very involved with crisis events while at Goldman and Morgan, wrote a funny book about the financial crisis. []

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{ 116 comments… add one }
  • 101 Vanguardfan March 13, 2020, 3:40 pm

    Ok so I had to google VaR…
    Just back from an inspection of the battleground of my investment accounts. I did still have enough gains to justify some selling, we will see how difficult I find the buy decisions in the next few weeks. The accounts where I hold 100% equities are not looking pretty, but overall, with my 30% cash and 20% bonds, I am happy I can wait for as many years as it takes.
    I did notice that the bond holdings have started to slide as well now. I guess that must be related to what ZXwas talking about further up thread.
    But overall, my portfolio worries are very minor compared with my worries about my loved ones over the coming weeks and months. I would love to be out the other side knowing that I, and those precious to me, had survived.
    Good luck everyone, and special thoughts to anyone in frontline services.

  • 102 The Rhino March 13, 2020, 3:50 pm

    @ZX – that sounds brilliant, but way above my pay-grade! (I don’t really understand any of it;)

    I’d love to see a post with ZX wealth strategy pitted against TI wealth strategy – a clash of the titans, battle to the death. Who emerges victorious?

    I’d say a 7 figure income is also something thats got to help you sleep at night? i.e. knowing you can rebuild if it all goes tits..

  • 103 SemiPassive March 13, 2020, 3:51 pm

    Arty – I was inferring that VHYL was the dumb one, not GBDV. Maybe it read confusingly.

    Edward – “For example, if the FTSE hits 5,000 or the Dow 20,000, stick 25% of your cash back into stocks. If it hits 4,500, stick 50% in etc.
    What if it all goes to toilet and the bottom is found at 3,000 or less, though?!”
    This is the dilemma anyone sitting on cash will find, though that is a possible method.
    For info I am sat on 20% in cash in my SIPP from partially selling out a week and a half ago – note this is frowned upon in here 😉 but as I’ve mentioned in a previous comment my asset allocation was a little too risky going into this whole thing.
    Anyway, another method for getting back in is to drip in a fixed % each and every month over the preferred timespan you want to get back in over. The % will vary depending on whether it be over 3, 6, or 12 months.
    The flaw with your suggestion is (as well as the FTSE hitting 3000) is the FTSE100 for example may never see as low as 5000, so what do you do then?
    The flaw with my suggestion will depend on whether we see a slow or fast recovery vs the time period chosen to scale in over. I guess at least you would be pound cost averaging back so unlikely to make too much of a booboo.
    But choosing that 3, 6, or 12 months timescale is a judgement call in itself.
    Pure passive guys and gals will let periodic rebalancing take care of things, but since I made an active decision to move a portion to cash it requires another active decision to reinvest.

  • 104 Learner March 13, 2020, 5:06 pm

    This is an interesting one, unlike the GFC we can expect a natural end to the virus impact when a vaccine is developed or it runs its course. At some point that recovery will be priced in. There is the risk that unemployment rises, creating a recession that runs independent of the virus though. That possibility looms larger than the health stakes.

    > Interest rates should go up, pretty quick, to something like historical, market-based norms, not down – or we face true and total economic carnage.

    has been the song of the past 8 years at least.. if the longest expansion in history couldn’t get rates above 3%, nothing will. The 21st century economy will not look like the 20th.

  • 105 Matthew March 13, 2020, 5:17 pm

    It helps I think to not think of the portfolio as x% of net wealth but rather as a pot for year Y, my net worth took a big swing, but I can tolerate it because its seperate from my wedding savings and not needed anytime soon – if you cant wait out the dip, and do whats generally best long term (ie not time the market) – then it shouldnt be invested, or at least not in anything stronger than say vls20

  • 106 The Investor March 13, 2020, 5:19 pm

    I’d love to see a post with ZX wealth strategy pitted against TI wealth strategy – a clash of the titans, battle to the death. Who emerges victorious?

    Haha. If you think @ZXSpectrum48k’s strategy is hard to follow, good luck with mine. At least his is explicable, seemingly mathematical, and follows a defined process. I’m old-school active, take what he would see as inordinate idiosyncratic risk, huge turnover, high costs, gut feel (/behavourial speculation) and so on.

    One of the many (many) reasons I don’t often write about the specifics of how I invest actively here is the information would be precisely useless to anyone, except perhaps anyone with a box of popcorn handy. 😉

  • 107 Tony March 13, 2020, 5:20 pm

    Lots of astute points made here. Timing the bottom is gambling. The duration and impact of Covid-19 on the domestic and global economy is presently unascertainable. Timing the recovery is gambling- U, V or L shaped. I like the idea of setting a floor as some have if lump sums are being invested. Although there’s a difference between buy and hold and day trading. Buying at current rates, well it’s pretty likely after 5 years and hopefully much less, markets will be far higher than today. Let’s not also not forget the elephant in the room- Brexit uncertainty is lurking underneath and will rear its head again this year. Double stress to the economy and business.

  • 108 Pre ka March 13, 2020, 5:47 pm

    Months available to buy back in?
    Years for the stocks to get back to record highs?
    What decade are we in?… with information processed within seconds and getting faster as we speak, buying time and recovery times will get faster and faster…
    Wait and you will all be left behind.

  • 109 Matthew March 13, 2020, 5:48 pm

    @tony – there will be less for brexit to destroy now, arguably covid has hastened the demise of a fair amount of brexit vulnerable businesses and therefore the economic adjustments we’ll have to make, and it could affect some countries worse than others, totally changing the value of a deal with x y or z.
    Covid will cause a worker shortage in the short term but might ultimately reduce the number needing social care, and thus worker demand

  • 110 MrOptimistic March 13, 2020, 6:08 pm

    I am surprised the fall of GBP against USD doesn’t get more if a mention. It is quite dramatic and whilst to the apparent advantage of the FTSE, a future unwinding could add a headwind.

  • 111 Edward March 13, 2020, 6:12 pm

    To Tony and Pre Ka’s points, looking back at the FTSE since 1999 shows how fools rushed in where angels feared to tread.

    FTSE was over 6700 in Dec 1999, collapsed to less than 4500 in the summer of 2001, but then rose back to 5200 before plummeting down to 3,600 by Feb 2003. That’s nearly a 50% fall over the course of three years, but no doubt many people were congratulating themselves for buying in around 4500 thinking that was the bottom.

    Having taken another nearly eight years – until July 2007 – to get back to its 1999 peak of 6700 it took less than two years to drop back down to 3750, a 44% fall.

    Obviously we should be diversified both geographically and investments wise, but using the FTSE example as a proxy, who can possibly predict how low we go this time, and how much faster will we get there?

  • 112 Brod March 13, 2020, 6:47 pm

    @Neverland – yes exactly. Fiscal expansion, fiscal expansion and er… dunno. But I’m not sure what effect that would really have. Isn’t that just an accounting trick to make the Govts debt look less so they can spend more? Aka fiscal expansion?

  • 113 Sparschwein March 13, 2020, 6:47 pm

    +1 for the @ZXS vs @TI strategy battle (readying the popcorn)

  • 114 Sparschwein March 13, 2020, 7:10 pm

    Quite like the GFC, there is the possibility of contagion across the financial system.
    Yesterday the FT reported “severe strain” in the US treasuries market, usually the most liquid of all.
    Today’s Economist lays out the systemic risks from corporate debt (“In a sea of debt”).

    In 2007, few predicted the consequences the subprime bust would have.

  • 115 Sparschwein March 13, 2020, 8:06 pm

    @SemiPassive – I am in the same dilemma, largely because of an ill-timed pension transfer. From the first scientific studies about the virus, the reports from doctors in Italy and the bungled response in the US, I had a hunch that this will get worse before it gets better. I believe it is inevitable that the US and the rest of Europe go the way of Italy. We will get overwhelmed healthcare systems and a shut-down of the economy.

    It’s a gamble to stay out of the market of course, and equally it’s a gamble to buy now. It’s a matter of how we assign probabilities.

    Stay safe, everyone.

  • 116 Tony March 13, 2020, 8:38 pm

    Edward: reread.my post as a whole pls. Not much different than yours. And I didn’t mention the FTSE.
    Mr Optimistic- indeed. GBP down against EUR too.

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