Swinging Smart: Navigating Market Curveballs with Prudence

Clients often ask how we manage portfolios amid current or expected market volatility. Imagine that you had advance notice that the United States would bomb Iranian nuclear enrichment facilities on a Saturday night, and you could place any trade you wanted. A rational investor may have predicted that the price of oil would go up while stock prices would decline in a flight-to-safety reaction. That investor would likely be surprised to see markets posting the opposite result on the following Monday. This serves as yet another example of the challenge of predicting market reactions with any degree of certainty.

Asset prices represent investor sentiment about possible outcomes. Let’s revisit our opening topic. The markets evaluated a range of scenarios regarding Iran for the weekend, each with a theoretical result for where oil would trade: a nuclear war in which oil prices spike (low probability), a complete peace deal in which prices fall (low probability), limited U.S. engagement (higher probability), or the status quo (highest probability). When a likely outcome occurred, prices stabilized.

Large reactions in prices, either up or down, result from an event that previously was assumed to have a small likelihood of occurring. That could include a company posting impressive earnings, an unanticipated monetary policy change, or a surprising news headline.

For portfolios, this means adjusting risk based on confidence. When uncertainty is high and confidence in assigning those probabilities is low, the best course of action is to shrink position sizes and diversify allocations to preserve capital. When confidence in those assigned probabilities is high, you should make larger, more concentrated bets to achieve optimal returns.

For baseball fans, a way to illustrate this is to imagine you are up to bat. If you are down in the count with two strikes, you would choke up, shorten your swing, and aim to get on base. If you were up the count with the bases loaded, you can take a big swing and try to hit the ball out of the park. But even when you are expecting a fastball down the middle, always remember that a knuckle curve can take you by surprise. Invest accordingly.

As we’ve written before, at KoCAA, we prioritize a conservative, prudent approach to client asset allocation with a focus on long-term results. We aim to design portfolios that can withstand any event – or pitch – that may come our way while staying on track to achieve a client’s objectives.