Although there are many superficial reasons to be enthusiastic that strong market performance can continue, most positives are overstated and many risks are underappreciated. In fact, today's investment environment entails such a high degree of uncertainty that most investors would be best served by simply minimizing their worst case scenario.
The widespread indifference to risk in the markets strongly suggests something is wrong. That something is “bad promises” and it has significant and widespread implications for investors.
After a long period of “riding the wave” of central bank liquidity, investors are now confronted with much more difficult decisions. Andrew Lo’s new book, Adapative Markets, provides an excellent framework from which to analyze the current situation, evaluate market risks and prepare for changes.
The persistence of exceptionally low volatility has created a perception that it will be “smooth sailing” for stocks. Evidence suggests just the opposite, however; now is the time to focus on protection.
The good news is that economic problems are fixable. The bad news is that they need to be properly diagnosed and treated first. Investors need to handicap the degree to which this will happen.
An investment landscape of increasingly binary outcomes requires fundamentally different involvement by investors. Importantly, those taking their cues primarily from the US economy are likely to be woefully unprepared.
One of the key insights revealed by the presidential election is that there has been a significant gap between perception and reality in regards to a number of economic issues. Resolution of these issues is likely to be messy and involve change that will affect investors in many ways.
It is easy to overlook public pension plans as a serious investment risk but the reality is that the level of underfunding is a threat to everyone’s financial health.
Weakening productivity growth poses serious risks to the economy and, by association, to stocks. One key piece to the puzzle is that productivity growth requires not just technological change, but also the diffusion of that change across the economy.