Risk in Realtime

These past 3 months have me thinking a lot about risk…

I played Risk a few times as a kid but never really understood the game. Throughout my adult life, however, I’ve become more and more attune to risk – how to decrease risk while maximizing reward. I’m always amazed to see folks who don’t understand the rules of risk (or Risk) at all…

The balance between risk/reward has become a lifelong ambition and one of my favorite topics to discuss because it encompasses literally everything – investing, personal finance, career choice, housing choice, the car you drive, the vacations you take, your hobbies, and so on…

It’s been fascinating for me to watch risk play out in realtime over the past 90 days. From news headlines to social media to 6′ face-to-face conversations, the nuts and bolts of most every conversations boils down to risk, and how it factors into life.

Health Risk

Obviously front and center on everyone’s mind is Covid-19 and its risk to the health of the world. This risk is manifesting itself daily. When we started this drama we were seeing cases of Covid-19 at a rate of 100,000 cases in the first 47 days and now we see 100,000 cases every 2 days. The risk is increasing exponentially.

In this we’ve seen a dramatic change in risk assessment. JWYHs and IJTFs have all but crawled under their beds and turned out the lights. They look plain foolish now having severely miscalculated risk.

One particular difference between the flu and Covid-19 is this – the flu opens you up to the risk of a secondary illness that can kill you (secondary pneumonia). Covid-19’s primary risk is pneumonia. The difference is akin to a disease that drops you off in a bad part of town and you hopefully find your way safely home (the flu) and a disease that just stabs you in the back itself right in your own neighborhood (Covid-19). Do you spot the risk delta?

Systemic Risk

Systemic Risk describes an event that can spark a major collapse in a specific industry or the broader economy. It’s been absolutely amazing to see this play out in realtime beginning Feb. 24. That’s when it started to get all wanky. By March 9 grocery store shelves began to get really thin. Sanitizing products gone, vitamins disappearing, and of course no toilet paper and paper towels at any price.

I got out in front of this early. On Super Bowl Sunday I was pantry-stuffing and loading up on Purell & Lysol products while shopping for gumbo supplies. I bought N95 masks and chemo-safe nitrile gloves that weekend as well. Call me hoarder, I call it preparedness. By Feb. 10 I had texted my buddy Chase Akers and told him to get to the store to buy a month’s worth of food supply as quickly as possible. As it turns out I was month early, but right on point.

The game of Systemic Risk is tricky. Stay prepared so you don’t have to get prepared, right? Others will label you in ways that will make you feel paranoid, foolish, or gullible. You may even feel foolish or gullible if you end up being wrong, wondering if you succumbed to paranoia. That is ok. This is an area where I don’t mind being wrong because when you are right you will be far ahead of the game.

Asymmetric Risk

If I’m wrong in this preparedness what is the foul? I won’t have to grocery shop near as often for the foreseeable future, eventually all the cleaning supplies will be used, I can use the N95 masks for mowing, painting, and woodworking projects, and the nitrile gloves are great for greasy car projects.

What is cost of being right versus being wrong? Is it asymmetric? Take wearing a face mask in public for instance. If I’m wrong and it does me no good (according to the “experts” with shining track records), I’m out $1 for the cost of a N95 mask (remember I purchased early). If I’m right, I avoid a potentially severe and costly disease. Same thing with my supplies, there is a vast asymmetry in the risk. This is how you evaluate (and win) the game of Asymmetric Risk.

Market Risk

This leads to market risk. By far, the best hedge so far against the risk of this market drop has been US Treasuries. Treasuries are up over 20% in some cases against market dips of -30% or greater. I’ve been able to capture that offset and take some gains in treasuries and buy equities selling at deep discounts. Sell high, buy low. That is how the game of Market Risk is won!

YTD US Treasuries (green, yellow, purple) vs. S&P500 (blue). Reference average in black

Market risk is also hedged by allocating across various asset classes. For instance, while the S&P500 ($SPY) is down around -20% YTD, the NASDAQ100 ($QQQ) is only down -9%. While most large, mid, and small cap asset classes are down -15-30% YTD, the micro-cap index ($PZI) is up +15% YTD . Hopefully your asset allocation is spread amongst these various asset classes in an effort to smooth out your ride and hedge out your risk.

Income Risk

Many are hurting here. Restaurants saw their business drop to near zero almost overnight. Bars were ordered to close while other businesses were told they are “unessential”. Many companies have been forced to furlough or lay off employees. Unemployment claims went from 281,000 to 3,283,000 in one week! One week!

Most don’t consider the risk from a singular source of income. Furthermore, and sadly, that singular income stream is rarely buffeted by a reserve. Dave Ramsey continuously preaches a 3-6 month emergency fund and is usually lambasted as too conservative from those I hear talking about his principles. I’m even more conservative and strive to keep 1 year in savings. Sadly, almost 50% of Americans would have trouble coming up with the cash to cover a $400 emergency.

This is the game of Income Risk. If you have no plan beyond a bi-weekly paycheck, it is hard to win this game. You’ll be boxed-in in no time with no out other than surrender. When this game is over it really, really sucks.

Credit Risk

Add to the fact that as many are losing their jobs, many are also leveraged to the hilt to live their everyday life. This means they are totally dependent on those jobs to make the payments their lifestyle requires. By leverage, I mean credit, and by credit I mean debt, and debt equals risk.

Today I see many headlines where folks are crying for relief. Many are pleading for mortgage and student loan deferrals. Some banks are deferring car loan payments up to 120 days. For small businesses, many lenders are offering 90-day deferrals on payments. Credit cards are offering to defer payments as well.

In all of this rest assured, the banks will get their’s. Deferrals mean interest continues to accrue and you will eventually have to catch up. You can look forward to higher monthly payments or a massive balloon payment down the road. For secured debt, you have assets on the line that the bank will eventually come and take (foreclosure). For unsecured debt they will make your life miserable with collection calls until they eventually sue you.

This is the game of Credit Risk. Look, in 6 months your creditors won’t give a bat’s ass about Covid-19, they will want their money. It’s fun to live above your means when it works, it’s hell when it doesn’t. If you play this game, God’s speed. I choose to sit this one out.

Conclusion

At the risk of rambling for far too long about risk, I’ll wrap this up. Cheers, and thanks for reading!

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