One of the more random books on my bookshelf at home is one I bought many years ago called “Self Defence in 30 Seconds”. The author, Robert Redenbach, is a specialist in teaching self-defence tactics. There are several passages that I think apply equally well to investing as they do to self-defence. He outlines the three phases of a pressure situation where you need to defend yourself as follows:
Phase 1 The Error
Phase 2 The Bubble of Confusion
Phase 3 The Result
In his opening sentence he writes: “There are only two rules for self-defence: 1) avoidance and 2) survival”. Avoiding bad situations seems obvious but it’s possible you take a wrong turn and end up in a dark alley in the wrong end of town. This is an example of an error.
From an investment perspective, everyone is still underestimating the dark alley of high interest rates and debt. That’s the error. I would love for a soft landing to be a real outcome. For the economy and for share markets. But if history and my experience are anything to go by that is not how it usually plays out.
The bubble of confusion he refers to is a 30 second window you get where you’ve walked down the wrong street, and you realise you made an error. You’ve got 30 seconds to survive what happens next. Still on the first page he states:
“… It is a tactical error to believe that if you can’t defend yourself in the first 30 seconds, more time in the affray is going to help. It won’t. It’s like trying to save yourself from drowning: if you can’t do what needs to be done in the first 30 seconds, more time in the water is going to make the situation worse, not better.”
For investors, the best option is to avoid being caught in the error. But if you can’t avoid it be sure you are positioned to survive it. That means reduced exposure to downside risk assets and reducing or even eliminating debt. These situations evolve very slowly, they build up over years and they take longer to peak than anyone expects. Then it all happens very quickly.
For investment markets, as it becomes clear that inflation is coming down and the economy slows investors will enter their own bubble of confusion. They will celebrate a return to the good old days (2010–2021) as they anticipate a return to low inflation and low interest rates.
With US inflation at 3.2% and Australian inflation figures released yesterday down to 4.9%, prices are no longer increasing like they were a year ago. The reason for the confusion is that the set of economic conditions that occur as inflation falls look the same as the early stages of the economy entering a more severe slowdown including a recession.
I expect the next 6 months through to mid-2024 to see much of the world enter this bubble of confusion. Investors will latch on to the ‘good news’ of lower inflation before realising that its actually ‘bad news’ as the lower inflation becomes a lead indicator of a global economy starting to slow more significantly. Frankly, it’s better that this happens sooner. If inflation rears its head again later it only forces rates higher and defers the eventual ‘bubble of confusion’ phase, making the slowdown more brutal when it arrives.
Australia will be especially vulnerable with inflation that’s now ‘homegrown’ and a reliance on potentially economically hobbled China. It’s a question of whether the economy, once it slows, settles to a nice soft-landing phase (what the market expects) or if it falls off a cliff (not what the market expects). These events tend to drag on until a sudden tipping point where things decline rapidly as the bubble of confusion ends with a result.
The path to a hard economic landing often looks and sounds like a soft landing until it’s not. In fact, I recently read a headline in the Financial Review stating that investors are expecting a “soft landing recession” I don’t even know what that means. Investors, commentators, and governments will contort themselves in every way to sound optimistic.
Ahead of every crisis I’ve ever seen over the last 25 years, I cannot tell you the number of times that almost every expert or government agency provided commentary or opinions that the emerging event was not in fact a crisis or a problem. Once there is clearly a problem the message becomes ‘it won’t last long’.
To be fair, governments are tasked with maintaining order, so they are going to provide the advice that’s required to ensure the best overall outcome. Investment institutions are tasked with making money, so they are never keen to talk negatively about markets.
This is very often at odds with the best outcome for any individual investor. Those messages are designed to manage the masses. More often than not as a crisis emerges, those proactive first movers who act counterintuitively to the crowd, recognise the problem and act are better off than the person who sits on their hands and lets it happen to them.
It’s critical how you assess the data as it emerges, how prepared you are, and how quickly you act will determine your result. These basic principles apply equally to managing investments in an economic crisis as they do in self-defence.
General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.