Two recent events have dominated the headlines: a spike in oil prices due to unrest in the Middle East, and a sudden weakening of Sterling following the governor's hint that interest rates could decrease faster than expected. Such news might lead to expectations of capital flowing out of the pound rather than into it. Reading these headlines, you could be forgiven for thinking the world is coming to an end.
When I was trading, these sorts of events really mattered. There was nothing like breaking news or unexpected economic figures to get dealers back at their screens, ready to react to any unanticipated outcome. The level of frenetic activity that would kick off immediately after an economic indicator came out unusually high or low was astonishing.
But unless you're an active trader, this sort of thing doesn't matter.
Most people who execute transactions in the treasury are passive participants—they are price takers rather than price makers. While it's better to deal when the market is trading normally because bid-offer spreads are relatively narrow, there's little benefit in trying to anticipate economic events or news to enter into transactions at more favourable rates, no matter how tempting it may be.
The reality is that what's news today will be overtaken by events tomorrow.
If we hang on to every headline, we're always looking for the next piece of news to frame our decision-making. Our decisions become constantly in flux, ebbing and flowing with events, leaving us feeling uncomfortable and uncertain.
The fact is, that tomorrow is unpredictable.
As for next month or next year, there's absolutely no way we can determine what will happen. And I can guarantee that whatever does unfold will be something unexpected. Remember COVID-19 and how it affected our lives? It came out of the blue like a meteorite.
Daily headlines may be interesting, but they are not helpful.
Reading too much into the news is positively damaging to financial decision-making. We're wired to be fascinated by bad news, which encourages us to consume more and more of it. We pore over the analysis that goes with it. Economists and observers write pages about what could happen as a result of recent events. This is speculation—it makes tenuous connections between current events and second-and third-order effects, making the likelihood of the prediction being correct so remote that it's not helpful. It's guesswork.
So, when does the news matter?
It matters when it unfolds into a major shock that is outside anything that can be perceived at the time and leads to permanent changes in income, consumption, employment, growth, productivity, and the global balance of power. Think of events like:
- The 1973-1974 Oil Crisis: This marked a turning point in global energy markets and had far-reaching economic and political consequences that continued to shape policy and market behaviour for decades.
- Black Monday (1987): On 19 October 1987, the Dow Jones Industrial Average lost 22% of its value in a single day, triggering a global decline across major markets.
- The Early 1990s Recession (1990-1991): Lasting five quarters, this recession was caused by high interest rates in response to rising inflation from the Lawson Boom and efforts to maintain British membership in the Exchange Rate Mechanism. It resulted in a 25% decline in company earnings and unemployment rising to 10.7% by 1993.
- The Global Financial Crisis (2007-2008): Triggered by the collapse of the subprime mortgage market, this crisis led to a severe global recession. The S&P 500 lost more than 50% of its value from its peak in October 2007 to its lowest point in March 2009. It caused widespread bank failures, credit crunches, and a sharp decline in consumer spending, affecting economies worldwide.
- The COVID-19 Recession (2020): While brief, this was the deepest recession since 1709. The majority of the GDP decrease occurred in March and April 2020 due to the COVID-19 pandemic. It triggered an inflationary shock and a wider cost of living crisis that continues to impact the economy. And while these types of shocks will happen again, you won’t read about them until they’ve happened.
These events share some similarities. They were all completely unpredicted; the sequence of what unfolded was beyond comprehension at the time. None of them became news headlines until they were already happening, and no amount of foresight or planning could have insulated you against them.
These are the very types of things we need to protect ourselves against in the future. But here's the paradox: you won't read about them in the news until it's too late, and the effects on your business will only be known after the event. So, is there anything we can do to improve our chances of survival?
Yes, there is.
We need to focus on the degree of flexibility we have in the systems or businesses we are running. For financial businesses, this means:
- Holding sufficient liquidity to buy time without it being ruinous.
- Having sufficient capital to cover unexpected losses.
- Spreading credit risks to maintain a balanced portfolio, ensuring that no single exposure is enough to create a solvency issue.
- Avoiding investments in long-term assets that cannot be liquidated in times of market stress.
- Not piling into uncharted areas of business just because the returns are so attractive that they cannot be ignored.
By avoiding the trap of reacting to every piece of news, we position ourselves to better withstand the unpredictable shocks that truly matter.
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