An Economic Hurricane

June 9, 2022

Last week, Jamie Dimon, the CEO of JP Morgan, warned of a coming “Economic Hurricane” and encouraged preparedness.  As an investor, that’s a dire warning.  What does Mr. Dimon mean by this?

There are several risks Mr. Dimon is pointing to.  Namely, the war in Ukraine, Fed action, rising rates, and persistent inflation.  To be fair, these are all issues which is part of the reason why the market has been so volatile.  However, they are also issues that could get better or worse from here, which is anyone’s guess.

We do have to take comments with a grain of salt.  There is a difference between running a bank and managing a personal investment account.  One big one is regulation.  JP Morgan’s balance sheet is subject to certain testing, capital requirements, etc., on a shorter-term basis.  So, part of diligent management of that balance sheet means reacting to these named risks, which is different than personal investing and the time horizon there.

Even so, what if you were to heed Mr. Dimon’s warning?  What would you do?  Let’s look further at potential moves:

    • Rising Rate Risk – If rates continue to increase, you will likely see core bonds continue to struggle for the short-term. Eventually, that struggle ends, and the go-forward expectation of bonds is even better than today, but the journey can be painful.  If you wanted to sidestep the pain, you could go to cash or stocks.  The risk?  Cash is a guaranteed loser to inflation, and stocks can drop severely.  Rates also could fall or stay relatively calm, in which case you’d be wishing you held onto your core bonds.
    • Rising inflation Risk – Inflation is not transitory, and we are likely to see this elevated for many months, if not years. If you were worried about inflation, you could allocate more of the bonds towards Treasury Inflation Protected Securities (TIPS) or to stocks.  After all, stocks, over time, tend to be a great hedge to inflation.  You could also look to commodities.  The risks here?  TIPS need more inflation than you think, stocks can go down, and commodities aren’t always doing what you hope.  The 15-year track record of the Bloomberg Commodity Index is -1.08% per year through 6/5/2022, despite a 40% rise in the last six months.
    • War in Ukraine Risk – The risk here is further escalation, including the potential threat of nuclear war. That is a disastrous outcome on all fronts.  However, if it were to happen, it would likely induce fear.  Past market events that induce fear have led to a flight to safety where investors move to U.S. Treasury bonds.  The risk here?  See the first point – what if rates rise?

Any of the above risks could materialize, but in investing, we must live in a world of probabilities instead of absolutes.  We also must understand relative risk vs. absolute risk.  Let’s look a little deeper:

    • Probabilities – Any of the above are possible, but would you allocate a portfolio to be positioned 100% for one of the above risks? If so, you are saying two things: 1) You have no chance of being wrong, and 2) You are comfortable allocating to one risk at the expense of another risk because, just in the example above, one scenario suggests stocks while another suggest bonds.  This speaks to the constant need for diversification.  Diversification, by definition, is spreading out what risks and opportunities you are exposed to.
    • Relative Risk – The market is constantly pricing in expectations. Just think about TIPS.  These can be good with unexpected inflation spikes.  What do we have right now?  Expected  So, for these to continue to be a good investment going forward, and not just in the review mirror, inflation must be even more of an issue than the market thinks.  Is it possible?  Absolutely, however, we know the market has a pretty good track record over time.

It’s always important to be mindful of what risks are out there.  If we aren’t, it’s easy to lose perspective, and then a portfolio becomes too concentrated (Google recent media articles on Tiger Global).  As a side note, on the very same day, the comments came from Mr. Dimon about an economic hurricane approaching, a JP Morgan economist said there would be no recession.  The reality is no one knows for sure, but diversification helps through whatever type of weather event may be on the horizon.


Disclosures:

The Bloomberg Commodity Index is composed of futures contracts on physical commodities and represents twenty-two separate commodities traded on U.S. exchanges, with the exception of aluminum, nickel, and zinc.

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