2020 Hindsight

Chadwicks

Well, it was certainly a very busy last quarter to cap off what has been an extremely tumultuous year!

Financial markets were jittery during October as the ‘2nd wave’ of COVID-19 infections really took hold in Europe and the US. Thankfully, November saw the arrival of viable vaccines and a Biden win in the US elections which helped fuel a remarkable bounce in markets. The month of December was far quieter for markets despite the news that a Brexit deal had been agreed and a new far more infectious variant of the virus had been discovered in the UK.

Despite the disruption caused by the virus, the World’s financial markets have had a strong year with most markets finishing the year in positive territory. However, the UK market has been the ugly duckling among international markets in 2020 largely due to its heavy exposure to oil companies, which have had a terrible year as demand for oil dropped off a cliff when countries across the World implemented draconian measures to suppress the transmission of the virus.

With all that has happened during 2020 it is an appropriate time to reflect and consider the lessons we can take from this, and past experiences.

Learning from history and experience

Without a doubt the pandemic is the biggest world event for at least a generation, posing possibly the sternest challenge the world has faced since World War II. Fortunately, the news that highly effective vaccines have been developed means that we should now be at the beginning of the end in terms of the pandemic upending our lives. This short note is intended to highlight just some of the lessons we should look to take from history’s big events.

Be prepared for the highly improbable

In the UK death from infectious disease went from the most common cause of death in 1915 to one of the rarest by 2015. The dramatic decline in the number of people dying from infectious diseases in the 20th Century was driven by factors such as mass vaccination programmes, rising living standards, and improvements in nutrition and hygiene.

Over the last century we have become so good at preventing pandemics that few people before January 2020 assumed an infectious disease would ever impact their lives. Many epidemiologists have consistently warned that we have been overdue a pandemic and that it was only a matter of time until one would befall us. However, as a society we became complacent and began to believe that pandemics were a historical malady or something that happened in less developed countries.

It is therefore arguable that if COVID-19 had happened in the early to mid-20th Century society would have been much better prepared as our collective understanding of the danger presented by disease outbreaks would have been far fresher in our minds. Moreover, as we have become further and further removed from past events, we no longer have a grasp of the risk posed by a pandemic striking, consequently we have been content in seeing our taxes diverted from funding medical advances aimed at tackling infectious diseases into other areas that could be perceived as being more deserving and in need of immediate attention.

More than 100 years of ‘calmness’ in relation to infectious diseases has understandably bred complacency. We see the same type of thing happen to economies and financial markets. When there are no recessions or market crashes people take on more and more risk, then when financial meltdown does occur the impact tends to be far worse than if people had been cognisant to the actual risks and behaved in a more responsible manner.

Good times come and go, as do the bad times. Whilst history may not repeat itself it does at least rhyme, however, we as humans have a habit of forgetting this.

Buy and hold: Save like a pessimist but invest like an optimist!

Human progress and the improvements that we enjoy as a society are a slow and gradual process, taking far too long for anyone to notice let alone make the evening news. The stories that grab people’s attention tend to be the bad news stories that happen instantly. History has shown us time and time again that in the long run things are generally pretty good however, in the short run it is usually pretty bad.

Investors require a great deal of skill and patience to reconcile the internal conflict of being a short-term pessimist but an optimist in the long run. For at times investors’ can just feel that they simply lurch from one setback or crisis to the next without ever growing their wealth. However, these short-term problems in fact work in the favour of the patient and disciplined investor with a long-term view. As the glorious effect of compound investment returns only really kick in over the long run. Compounding simply means the ability of a sum of money to grow exponentially over time by the repeated addition of earnings to the principal invested. This effect is so powerful that Albert Einstein once described it as the 8th wonder of the World. The skill lies in being able to stick to the plan long enough for compounding to work its magic.

Large events have several causes

The world is an incredibly complex place and is thankfully stable enough so that one person or company cannot in isolation cause an event that impacts the whole world. However, what does happen is that unrelated things collide all the time to shape the world we live in. The film director and documentarian Oliver Stone described history ‘as the story of lots of things happening at the same time’. If we think about the year just gone for example there has been the perfect storm of events that culminated in the pandemic. A virus jumps from an animal to a human, that human then mixes with other people, as the virus spreads among a small group of people it remains a mystery for a while, once authorities realise that it is a new virus, they try to suppress the news at first in the hope that the outbreak would be contained. Unfortunately, other countries believed it would be contained and failed to act fast enough in dealing with the virus.

It would be fair to characterise the initial response from the major developed countries as over optimistic and even arrogant. As evidenced through the lack of preparedness and denial that the developed world would be affected by the virus. There was a belief that we would come through this episode relatively unscathed. Yet, when the first wave hit it became abundantly clear how unprepared we were, leaving panicked Governments with only one option left to respond to this new threat: lockdowns.

Be careful not to dwell on past events

It is important not to be defined by our bad experiences. Whilst it is vital to learn lessons from powerful and extraordinary experiences, we must be careful not to learn too much from the unusual nature of these experiences. Events like the 2008/09 financial crisis and current pandemic are so rare that most of us will never go through anything like it again. When discussing the stock market crash of 2008/09, the investment consultant Charles Ellis put it best when he said that ‘you don’t want to be so well prepared to go through it again that you lose the chance to have positive experiences for the more normal part of life’. This applies even more so to today’s present situation.

Many investors learnt valuable lessons the hard way during the Global Financial Crisis. The magnitude of the financial crash and widespread bank failure understandably shook many people’s confidence in the global financial system to such a point that many investors were so exhausted by the unrelenting stock market losses that by March 2009 they sold their investments and put their money into cash, but by doing so they turned a temporary loss in to a permanent loss. The lesson from this is not to let our current experiences disrupt our long-term plans.

Predicting the future is a fool’s errand: Flexibility is your friend

Most of time the biggest risk to our way of life is from the risks we do not see coming. At the start of 2020 if you had asked any economist or investor to list the main risks to the economy, they would likely have said trade wars, Brexit and tightening monetary policy (increasing interest rates too fast). Yet, it was a virus that no one saw coming, which ended up causing havoc to the global economy on a scale that would have been scarcely believable back at the start of 2020.

The way to approach an uncertain future is with a plan flexible enough to react to the changing environment. We find it useful to build financial models for clients that help give us a guide to what the future may look like. We build these models using a set of macro-economic assumptions about economic growth, investment returns, interest rates and inflation rates. We then overlay this with assumptions about tax, life expectancy and household expenditure. However, none of this can ever take account of the possibility, however remote, of outlier events like wars or political crises or natural disasters or pandemics.

With vaccine rollouts gathering pace we are hopeful that 2021 will be a far better year than 2020.

James Bacon Investment Analyst

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