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  • In a brief review of financial market headlines of the last half-decade, one thing is certain: pundits are very, very bad at predicting where risk will actually be realized. 
  • The effect of the media’s ever looming “next crisis” seems to have taken a significant psychological toll on investors.
  • U.S. investors have, on average, over 30% of their wealth currently in cash.
  • Prudent risk management is not about trying to play crisis whack-a-mole where we try to identify where and when the next crisis will be.  Rather, prudent risk management is about creating a portfolio that is robust to any number of uncertain futures.

“Come to our seminar,” the advertisement began.  “Where our experienced team will teach you how to buy, renovate, and flip houses.”  This sounds oddly familiar, I thought.  “All while using other people’s money!”  Oh no.

I checked my phone.  Nope, still 2016 – I haven’t somehow time travelled back to 2006.

It was hard to not suddenly think of the apocryphal stories of the stock-tipping shoe-shine boys of 1929 or the dot-com prognosticating taxi-drivers in 2000.  Or the very same advertisements that were playing just a decade ago.

“Housing bubble 2.0?,” I thought, “or the final death rattle of yester-year’s crisis?”

And then I remembered that prudent risk management is almost never about playing crisis whack-a-mole and got back to my day.


A Brief History of Crises that Never Happened

The problem we face is that crisis whack-a-mole gets airtime on CNBC.  Crisis whack-a-mole gets the book deal.  Crisis whack-a-mole can make you a movie star.

Yet as fun as the crisis prognostication is, the reality is that the history of financial markets is littered with more crises that failed to materialize than ones that actually did.

Pausing to take a look at the headlines over the last half-decade tells us something important: we’re either constantly perilously close to all-out catastrophe or we’re pretty bad at estimating risk:

            “Debt crisis unsettles European economy,” The Washington Post, February 9, 2010

            “Greece accepts bailout package,” CNNMoney, May 2, 2010

            “Fears grow over length of US jobs crisis,” Economic Times, December 3, 2010

            “United States of America [Credit] Rating Lowered To ‘AA+’ Due To Political Risks, Rising Debt Burden,Standard & Poor’s, August 5, 2011

            “Financial crisis: Italy could tip euro into abyss,” Telegraph, August 7, 2011

Occupy Wall Street: Civil society’s awakening,” LA Times, November 22, 2011

Worries Grow Spain Will Need Broader Aid,” Wall Street Journal, June 14, 2012

            “U.S. approaches ‘fiscal cliff,’ and world watches from the sidelines,” The Washington Post, November 2,

            “Stock Investors Spooked By Sequestration Fears,” Wall Street Cheat Sheet, February 28, 2013

            “Stocks tumble as Bernanke discusses tapering,” USA Today, June 19, 2013

            “Government Shuts Down in Budget Impasse,” New York Times-Oct 1, 2013

            “Fed to taper bond buying by $10 billion a month,” CNBC, December 18, 2013

            “Russia’s Putin Signs Treaty to Annex Crimea,” Wall Street Journal, March 18, 2014

            “Oil prices plunge as production rises,” Washington Post-Oct 15, 2014

            “Fed Ends QE, Perks Up Labor Market Outlook,” Forbes– Oct 30, 2014

            “Ebola Epidemic Not Even Close to Over, UN Officials Say,” NBC News, November 21, 2014

            “Strong Dollar Hammers Profits at U.S. Multinationals,” Wall Street Journal, March 22, 2015

            “Greece debt crisis: Has Grexit been avoided?,” BBC News, July 20, 2015

            “World markets plunge as China stocks crash,” CNN Money, August 24, 2015

            “Fed raises interest rates, citing ongoing US recovery,” Reuters, December 16, 2015


European debt crisis.  U.S. debt downgrade.  Crises in Italy and Spain.  U.S. fiscal cliff and sequestration.  Taper risk.  Conflict in Crimea.  Ebola.  Grexit.  Strong dollar.  China market crash.  Crashing global commodity prices.  Fear of rising rates.

We do not want to downplay any of these events: they each had very real adverse effects on people around the globe.  For the average American investor, however, they were more-or-less meaningless from a portfolio return stand-point.  After all, the 5-year risk-adjusted return of the S&P 500 from 2009 to 2014 was better than even the dot-com era.

Of course, this presumes that the average American investor was invested.  Which, it turns out, they probably weren’t.  Our post-2008 crisis du-jour merry-go-round has created such a looming feeling of impending doom that investors may be inadvertently fulfilling their own catastrophic prophecies with a crisis of confidence.


Quantifying the Crisis of Confidence

State Street’s Center for Applied Research recently published a summary piece that culminated 18 months of research into investor behavior.  The results are, frankly, terrifying:

SSgA Allocations

Source: State Street’s Center for Applied Research.  URL:

What we see is the massive paradox between how investors are defining success – being on track to achieve long-term investment goals – and the percentage of their wealth they have invested in assets with similar horizons.

Cash – with its negative real return – represents over 30% of an average U.S. investor’s portfolio.  Put another way: investors are so fearful of another 2008 they are willing to guarantee the very real long-term losses of inflation and opportunity cost.  You don’t need a market crash to lose purchasing power: 20 years at 2.5% inflation will make that cash worth 40% less than it is today.

Perhaps the only thing scarier than the structural de-risking investors have undergone is the behavioral traits investors have adopted.

SSgA Risk-Aversion

Source: State Street’s Center for Applied Research.  URL:

What we see is that investors are so fearful of losses that they have not only become risk-averse when it comes to opportunities for additional return, but they’ve become risk-seeking when it comes to avoid losses.

Versus a guarantee of losing $80,000, 86% of investors said they would rather take an 80% chance to lose $100,000 – $20,000 more – given the 20% chance to lose nothing.

Better to go down swinging?


The Transformation of Risk

We’ve said it before and we’ll say it again: risk cannot be destroyed; it can only be transformed.

What we see today is that investors are more than willing to trade in the risk of uncertain, but potentially large, losses for the nearly certain decay of purchasing power and growth opportunity.

The problem is that prudent risk management is not about trying to play crisis whack-a-mole.  We should spend very little time and effort trying to time when and from where the next crisis will emerge.  After all, it will likely be a crisis precisely because so few people identify it as a risk.

Rather, prudent risk management is about trying to be robust to the vast number of uncertain futures we can face. 

Sitting in cash may feel good for investors, but the reality is that it trades in one set of risks for an entirely new, and potentially far more dangerous, set.  For these investors, the next crisis may not be suffering some large single-year market drawdown – rather it may be waking up 20 years from now and realizing that inflation has left them in the dust.

Corey is co-founder and Chief Investment Officer of Newfound Research, a quantitative asset manager offering a suite of separately managed accounts and mutual funds. At Newfound, Corey is responsible for portfolio management, investment research, strategy development, and communication of the firm's views to clients. Prior to offering asset management services, Newfound licensed research from the quantitative investment models developed by Corey. At peak, this research helped steer the tactical allocation decisions for upwards of $10bn. Corey holds a Master of Science in Computational Finance from Carnegie Mellon University and a Bachelor of Science in Computer Science, cum laude, from Cornell University. You can connect with Corey on LinkedIn or Twitter.