You have not read an optical illusion, nor have I mangled a familiar cliché. Sometimes to stand there – to do what you have been doing -- is the best course.
When circumstances unravel, when fear sets in, to do something is the imperative that will overwhelm the mind. We demand most of all an expedient to relieve the discomfort. We poke and prod. We look for someone to acknowledge and confirm our discomfort. What’s expedient is too often sought in novelty, ad-hocisms, a change on the fly, something different from what we have been doing that got us here.
When you’re inserted into a situation where the causes for the discomfort are systemic, you’re usually served best by sticking to your initial plan. If the plan has proved its worth, it will likely prove its worth in the future. Patience, my dear, patience. Stand there, in other words, keep doing what you’ve been doing.
The stock market has inflicted heaps of discomfort in 2022: inflation, the war in Eastern Europe, rising interest rates, recurring recession babble, those niggling Covid flare-ups in China and elsewhere. Many investors today are fidgeting and asking, what now? Surely, there is something better?
These questions should have been asked and answered before 2022. If you have a plan and you know the systemic is also the repetitive, the intelligent plan should provide for the systemic. Events that roil the market are nothing new. (Every intelligent investment plan should provide for a “panic” every eight to ten years. Walter Bagehot noted the propensity for recurring panics in 1873 in his book Lombard Street: A Description of the Money Market.)
The discomfort of a depreciating portfolio (albeit temporary, if you have adhered to an intelligent plan and dollar-cost averaged and ignored front-loading everything at an October 2029 high), can induce discomfort, and then desperation among those with weaker constitutions and masochistic tendencies – mostly, the tendency to monitor every hour a portfolio constructed not to be drawn down until decades hence.
It starts with the fiddling, the adjusting on the fly, the resorting to ad-hocism. Most of it, nay, all of it, favors what everyone else favors. How do I know? Interest in gold, commodities, treasury inflation protection securities (TIPS), is on the rise. The price of these assets is at multi-year highs. More investors are allocating, or have allocated, more of their portfolio to these assets this year. These assets flash green today because they flash so frequently.
History suggests investors are buying or have bought fashionable assets after the horses have not only left the barn but have galloped somewhere over the horizon into the next county. If they had implemented an intelligent plan from the outset, such improper adjustments would be unneeded, and not even addressed. They wouldn’t be buying gold, commodities, TIPS at market highs.
These acts on the fly can seem benign, but they can mask fomenting trouble. Little actions can compound to end in real disaster. Let’s wander outside the field of finance into the field of aviation for a parallel construct. I look at the plight of Air France 447 as an example of the perils that can arise when small deviations from a well-thought-out plan during times of discomfort can produce a colossal disaster.
Air France Flight 447 was to be an eleven-hour trans-Atlantic crossing from Rio de Janeiro to Paris. The aircraft, an Airbus A330, departed from Rio de Janeiro-Galeao International Airport at 7:29 PM local time on May 31, 2009. The plane was scheduled to arrive at Paris-Charles de Gaulle Airport at 11:03 AM (local time) on June 1, 2009. It never made it. Why? Because the pilots failed to stick with a proven, intelligent plan. Moments of discomfort lead to a confluence of ad-hoc, on-the-fly responses that downed a perfectly serviceable modern jet and ended 228 lives.
It all started to go wrong four hours into the flight. Flight 447 had entered an area of heavier weather as it passed over the equator while flying over the Atlantic. The cockpit, manned by two co-pilots (junior officers both, the captain was resting in the back), found themselves enduring a continuous nerve-fraying pelting of ice crystals hitting the windscreen. The weather was rough, a bit harrowing even, to be sure, but the turbulence was only light to occasionally moderate.
The night was to become more discomforting. Unbeknownst to the pilots, the ice crystals had accumulated inside the airplane’s three air-pressure probes, known as pitot tubes, which were mounted on the underside of the jet’s nose. The clogged pitot tubes caused the autopilot to disconnect.
The pilots were surprised, but the A330 remained in a steady cruise mood, pointing straight ahead without pitching up or down, and with the power set to deliver the prescribed .80 Mach. The pilots lost the airspeed reading, but the airspeed itself was unaffected. No crisis existed. The episode should have passed as an inconvenience, and one that would not last long. The pilots were now in control, and if they had done nothing, had they stood still, they would have done all they needed to do.
But one pilot was keen to do something, to adjust on the fly. He had earlier expressed discomfort with the weather. He had expressed a desire to search for calmer air at higher altitude. An indicator showed the plane had deviated slightly from its selected 35,000 feet. With a slight control adjustment, the plane would be back on altitude. Instead, the pilot, nervy from the weather, pulled the stick far back instead. Perhaps the pilot overreacted, perhaps he considered the deviation an excuse to seek smoother air at a higher altitude. Whatever the reason, such was his zeal, that he pulled back far enough to pitch the jet’s nose too high. A STALL warning sounded.
The warning should have convinced the pilot to rethink his adjustment and return to what he had been doing. Which was? I repeat: lower the nose to the normal cruising pitch and leave the thrust alone. Instead, the nervy pilot continued to pull back on his control stick, pitching the nose higher still.
More ad-hoc action followed. The other pilot looked away from the main flight displays, thereby abandoning his primary role as the Pilot Not Flying. The PNF’s primary role is to monitor the other pilot. Instead, he began to read aloud from a message screen that ranks and displays certain system conditions, and in some cases provides abbreviated advice on procedures. The advice was irrelevant to the situation, but it led the other pilot to switch off the thrust lock. This was the first of a series of ad-hoc acts that produce a seesaw power struggle that only fueled a bubbling panic.
Calmer minds might have prevailed, but these were not calm minds. The pilots summoned the captain from his berth. By the time the captain arrived, the cockpit had devolved into incoherence and chaos. Each pilot continued to act on the fly, and frequently acted at cross purposes with the other pilot. One pilot pushing a control stick, the other pulling another. Panic overwhelmed to the point it caused the pilots to ignore the most basic flying rules.
The cooperation that had devolved into incoherence and chaos in the cockpit had devolved into utter terror for everyone else. In the last minute everyone, the jet was flying 225 degrees due west from its mapped course. Its nose stretched up at a 16- degree angle. At this point, the jet was progressing at a mere 107 knots (minimum takeoff speed is 150 knots for a jet the size of an A330) despite full thrust. It was descending at a rate of 11,000 feet per minute.
If you think the tragedy required a meaningful chunk of time to unfold, think again. The transition to obliteration from the mundane required less than five minutes, such is the power of compounding small errors.
An extreme comparison on my part, perhaps. Air France Flight 447, nevertheless, offers an important life lesson, anyway: the value of adhering to a proven, intelligent plan. When you understand why you are doing something and you understand the best plan for doing it, stick to the plan. Empiricism trumps feelings, including those of discomfort..
Continual small errors compounded to devastate a modern jet and all its occupants. They can compound to devastate the expected terminal value of a perfectly modern portfolio.
And modernity it where it begins and ends in modern finance. I argue that the diktats of modern portfolio theory provide the foundation on which investors should base their intelligent plan. Such a plan mandates fund investments over individual security selection. The plan mandates adhering to a predetermined asset allocation based on proven empirical evidence.
Investing with knowledge and patience ensures the portfolio and terminal wealth will endure the discomfort market turbulence promotes. Consider the intelligent portfolio plan your mandate to remain at 35,000 at 0.80 Mach with a two-degree horizontal pitch at all times, with adjustments occurring only at predetermine intervals to ensure the portfolio adheres to the plan. Actions are considered neither for expediency’s sake, nor to temper anxiety fits. After all, if the plan is truly the intelligent, it is sure to account for the next recession, bear market, or panic.