Let’s start with a simple question. Where were you when the markets crashed in 2008?
So, in my career I’ve been an investor like I am at Wealthsimple, and I’ve also worked with other investors on particular investments. In 2008 I was working for McKinsey in Lagos, Nigeria, on some improvements for a portfolio company of a client. After the crash, that turned into an all hands on deck effort to steer this company through the crisis. So I saw the crash from the perspective of a company trying to keep the lights on.
Is what's happening right now like what happened then? It seems like the entire banking and financial system isn't currently threatening to collapse like it was then. Does that matter?
It matters, a lot. As you said, in 2008, the banking and credit system was threatening to collapse. So our worries were bigger than an economic slowdown. At the same time, our worries then were a lot smaller than today because it wasn’t a public health crisis with so many lives on the line. If the financial system had collapsed it would have meant that good companies couldn’t have gotten access to the funding they needed, so perfectly healthy companies would have failed. And that could have caused a downward economic spiral and, ultimately, a long depression.
This situation is not that.
Right now, people aren't participating in the economy as much because they are staying put due to the coronavirus. That slows down the economy, and corporate profits. There are some assets that do well when economic growth is better than expected, like stocks and oil. Those have been decreasing in value. Meanwhile, bonds, which often do well when the economy is struggling, have by and large been doing well.
I try to be even-keeled about this stuff. I haven’t looked at my personal accounts for about a week.
No one knows exactly how much of a slowdown will occur, and how long that slowdown will last, and that's why the price fluctuations have been so wild. Those fluctuations have also caused some strange things to happen where prices between pretty similar bonds, for instance, have diverged. That usually happens when investors need cash and they need to reduce the amount of risk they are taking.
In the short term, what will the economic pain look like? Who will be hurt by this and what are the factors that will determine how painful it is?
In the short term, we are seeing a slowdown in economic activity across the board. And it’s worse in some areas — travel, live events, some energy companies — than others.
Unfortunately, the economic pain will be felt most by the vulnerable people in society. Maybe you can't work at home, or you don't have much savings — it's hard for people like that to stay at home and have no income even if they are sick. And they're also the first to suffer as businesses need fewer workers. So the social safety net is really important at times like these.
Businesses will also suffer. Weaker businesses will suffer more than those that are stronger. This happens in most slowdowns.
The biggest thing that determines the amount of pain is the quality of the public health response. The open question here is: are we going to look like China and have a few-month slowdown or will it be worse.
So when people open their investment accounts, how should they be looking at their returns? How should folks figure out if they’re in the right investments in an atmosphere like this?
Overall, our portfolios are behaving according to our models, and performance is in line with what’s appropriate for different types of investors given these market conditions. That doesn’t mean our returns aren’t down. They are. But we build them knowing that there are bound to be downturns, mild and severe, over the course of time.
Is there ever a time you should change your long-term investments?
If your risk profile is wrong because you’re in a portfolio built for long time horizons but you will need your money soon, that’s a problem. And what you’re seeing now is why it’s so risky to put money you’re planning to spend in the near term at risk like a long-term investment.
If you look at your portfolio and the amount of loss feels too big, it’s possible you could be in the wrong risk profile and may need to change that. But emotion is generally the wrong thing to base your investments on. Weigh your emotion against long-term returns you need as well as your spending and life goals.
If you do have a longer time horizon and you can handle it, holding on at times like these is important. Taking enough risk, holding over a long time horizon, and keeping costs low is an effective investment strategy. Generally investors get paid for taking risk, and the discomfort you may feel at times like this is a reason why you get paid an attractive return over time.
So you’re saying your models are working. But my worry is that something that wouldn’t have been a problem in normal times will become a problem. Isn't it possible that this stress will expose invisible faults in the economic system and we could start to see a negative feedback loop that gets scary?
First of all, we can expect some fault lines to appear no matter what. When growth weakens, the companies that are weaker can really struggle. Some of them will fail.
One thing to keep an eye on to see how bad things get is the credit and banking system. What you don’t want to happen is for banks not to be able to make good loans because they don't have the cash. Or for investors to have to sell otherwise productive investments at a steep discount because they need to shore up their balance sheets. Then productive and strong companies can become casualties, which can make for what you called a negative feedback loop. And the economy suffers. So the extent of the impact will depend, of course, on the length of time it takes to recover from this virus, but also from the strength of the bank and credit system.
Right now, you don't see those extreme signs of stress in the banking system. For example bank credit default swaps, which are a good leading indicator of bank health, are pretty normal in the UK. They were much higher in 2008.
What do you think the possible outcomes are for the financial part of this crisis? What's the worst case and best case scenarios?
If we want a best case scenario, the most important thing is to help the public health response. That means practising social distancing and doing whatever you can not to spread the disease so that the health systems are not overwhelmed.
Financially, the best case scenario is that economic activity returns to normal in a relatively short time. And that any weird esoteric financial stuff that happened over the last couple of days (prices of similar investments being very different, for instance) is mostly avoided. Central banks — like the Bank of England or the European Central Bank — are trying to restore liquidity. That means that markets can perform their usual function of pricing financial assets and providing funding where it is needed. The best case scenario is those attempts are successful and assets behave in a fundamentally-driven way.
As long as assets do what they normally do and the credit system works, we will see lower economic growth from the pandemic and, then, an eventual recovery. It’s not like all of our factories have been destroyed. The variable is how long and how deep that decline in economic activity is, which is mostly a public health question, and also a fiscal policy question.
Financially, the worst case scenario would be that credit is removed from the system, which means that it gets really hard for anyone to borrow money. Then suppliers of credit don't have the ability to provide it to companies that are viable. Then there would be damage to the economy that wasn't a direct result from the damage from the virus. It would be a bigger hit and might magnify the impact of everybody staying at home.
In the short term what matters is the public health outcome — do we follow the trajectory of China or is the curve something worse? Is the hospital system ready to handle what’s coming? It’s important to remember that what markets have mostly been trying to predict is what the public health scenario will be, and how long the time-frame is for the disruptions of this virus. So that's what will determine whether things go well or badly both in the financial world and the real world.
Getting a little more personal. You’re an insider, a guy who understands how all of this works. What are you doing with your money?
I’m staying the course and not selling anything. I will deposit monthly savings like usual. I try to be even-keeled about this stuff. I haven’t looked at my personal accounts for about a week.
What can the government do about all this?
The government’s response is crucial. Most importantly for public health, but also to make sure the financial crisis doesn’t become bigger than it needs to be.
Financially, the government can step in to help the sectors most affected by the virus, for example by supporting municipalities that can't run deficits but need to provide a lot of services, or guaranteeing financing to affected companies. The government can also give people money directly by writing everybody a cheque or using the tax system to deposit money in everybody's accounts, which will help maintain spending, which in turn fuels the economy. Offering things like paid sick leave for workers who might be unwilling to take off work even if they're sick would help prevent the spread of the virus and provide stimulus.
And to keep the system from teetering, what you want to see is by and large what we are seeing: central banks providing a lot of liquidity and making sure the banking system works. On this last dimension, we are in better shape than we were 10 years ago. While some businesses will fail, the banks are looking relatively strong.
In the long run, as long as this doesn't become a banking crisis, and I haven't seen any indication that is on the horizon, you would expect to see a rebound in economic activity and asset values once this plays out.
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