In legal contracts, there is a clause called force majeure, which removes liability from unforeseeable and unavoidable catastrophes that may interrupt the normal course of events. If you were building a house in early 2020, a force majeure clause may have kicked in for your builder so that they weren’t penalized due to the unforeseen conditions of the pandemic delaying the construction of your home. What does force majeure have to do with investing though?
How does this relate to investing? Despite the seeming disconnect, understanding sudden market shifts is crucial for investors. Uncertainty is a key factor that investors must grapple with, and attempting to predict every possible outcome is impractical. Rather, our role in investment is to analyze vast amounts of data and make long-term decisions based on it. However, we all face the challenge of responding to unforeseeable events or rapidly changing information. Here are two recent examples that illustrate this point.
COVID-19
COVID-19 serves as a prime example. At the start of 2020, economic indicators were positive, and unemployment was low. Then came the reports of a new virus called COVID-19. At first, most of us paid it little attention, dismissing it as a common flu-like illness. However, the situation quickly escalated into a global pandemic, leading to the swiftest bear market on record. The outbreak was a Force Majeure, an unpredictable event beyond anyone’s control. It was unrealistic to expect anyone to have crafted a foolproof investment strategy to mitigate its effects. Instead, the best approach in many opinions was to adapt to the changing circumstances as new data emerged and make adjustments accordingly .
Hyperinflation And Housing
Another example of unpredictability is last year’s hyperinflationary environment. Despite some analysts claiming that it should have been easily predicted, let’s go back to the third and fourth quarters of 2021. Inflation was steadily rising to 5-6%, and many economists were calling it transitory or non-permanent. Even the Federal Reserve, composed of some of the most brilliant financial minds globally, believed inflation was transitory, and they only planned to raise rates three times in 2022 for a total of .75%. However, in reality, the Fed ended up raising rates seven times for a total of 4.75%, which was a drastic difference from their original plans. This was another instance of force majeure, where unpredictability played a pivotal role.
These examples illustrate why we often see sudden changes in the stock market. They’re easy to understand retrospectively, but they’re challenging to predict in the moment. A single unforeseeable event can blindside everyone, creating an element of unpredictability. As a result, there’s a complete repricing of assets, expectations, and investors must adjust accordingly. The 2008 housing crisis is another example of this unpredictability. Everyone assumed that mortgage-backed securities were great conservative investments until the day it became clear that they were terrible and grossly misrepresented. At the end of the day, how can a solid investment strategy cope with force majeure? Start by developing a robust and adaptable investment philosophy. Then, adapt to the new data and make adjustments as necessary.
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