Quarterly review, Q1 2021: investment and the Stockdale Paradox

Realism and optimism: the best of both worlds

During the past year, amid the maelstrom of the pandemic, you might have read about the Stockdale Paradox. This is a survival psychology whose central tenet seems well suited to our uniquely tumultuous times.

James Stockdale was a US Navy Commander during the Vietnam War. Captured after his jet was shot down over enemy territory, he was held at Hoa Lo Prison – the so-called Hanoi Hilton – for seven-and-a-half years. After his release he told how he endured his ordeal by striking a balance between realism and optimism: his willingness to acknowledge “the brutal facts of reality”, he said, was invariably accompanied by an unwavering conviction that he would prevail in the end.

It is easy to see how this philosophy might be applied to life during lockdown, but it should also be at the forefront of our minds whenever we think about investment. After all, although the reality is that we will all lose money at some juncture, the basic act of investing is undeniably rooted in optimism: everybody invests with the expectation of making money.

Around this time last year, as the gravity of the COVID-19 crisis became manifest, many of us saw up to a third of the value of our investments wiped out in just a few days. Some of us held firm in the face of a precipitous decline, while others exited the market.

Those who stayed the course were true to the ideal encapsulated in the Stockdale Paradox. They were realistic, in so far as they recognised that bad things happen; and they were optimistic, in so far as they believed that the story would eventually end well.

As the following examples of Invesco’s Q1 2021 thought-leadership outputs demonstrate, further challenges are likely to lie ahead. We are living in a period of astonishing disruption, and churn and change will endure even when the pandemic is finally behind us. But none of this is to say that we cannot adapt, discern opportunities among the risks and, above all, retain faith in a desirable outcome over the longer term.

Crisis and connectedness

The scope for genuinely “human” engagement was among the first casualties of the coronavirus. Self-isolation, social distancing and other outbreak-countering imperatives compelled businesses of all kinds – financial services providers included – to urgently reappraise their approach to relationships.

As explained in From Constraint to Catalyst: COVID-19, Technology and the Emergence of “Smart Relationships”, novel thinking has now not only filled the void: it has delivered solutions that should enhance client-centricity in any setting or scenario, whether good or bad. Using a cutting-edge combination of diagnostic, analytic and conferencing tools, Invesco has found that ever-greater digital integration with clients can substantially improve the transparency, frequency and depth of interactions between asset managers and investors.

Colin Fitzgerald, our Head of Distribution in EMEA, sums up the myriad gains in a related comment piece, Towards Smart Relationships. “What is now clear, at least to us, is that these unprecedented circumstances have catalysed a digital fast-forward towards the behavioural changes and technological innovation necessary to make ‘smart relationships’ a reality.”

The crisis has also shed light on another form of interconnectedness – that which links the numerous existential threats to our planet and its inhabitants. Appetite for Change: Food, ESG and the Nexus of Nature explores one of the least appreciated of these threats – the unsustainability of prevalent attitudes towards food production and consumption – and examines how it influences human health, loss of biodiversity, climate change and other phenomena.

The paper predicts that “interconnected causality” will become a major investment theme in the years to come. A key message for those looking to allocate funds in a responsible and sustainable manner, say the authors, is that efforts to encourage beneficial, lasting transformation in one area of the “nexus of nature” are also likely to bring about beneficial, lasting transformation in others.

With the current situation already constituting a “burning house”, swift action is vital. In the words of Cathrine de Coninck-Lopez, Invesco’s Global Head of ESG: “We need to break these links – or we need to turn them into positive links. And investors can play a huge role in making this happen.”

The road ahead

The extraordinary fiscal and monetary responses implemented to contain the economic impacts of COVID-19 have generated fierce debate in recent months. Rather than centring on what these measures have achieved to date, much of the discussion has reflected on what the longer-term repercussions might be.

One especially hot topic is the question of whether inflation will soon join the ever-growing ranks of new normals. As detailed in Anticipating Inflation: Historical and Multi-Asset Perspectives, our preferred answer is likely to depend on which school of economic thought we favour.

The “New Keynesian” view implies that the pandemic has wrought so much damage that levels of activity and employment will stay weak, meaning inflation will also remain suppressed. By contrast, the “monetarist” view suggests that the spectacular growth of money – specifically, money held by the public – will lead to a post-pandemic reduction in risk aversion, a concomitant boom in consumerism, another Roaring Twenties and, ultimately, inflation.

If the latter interpretation is correct – and if historical experience is any guide – we could see inflation in 2022 or 2023. In this instance, says the paper’s authors, it makes sense to think holistically and draw strength from across the asset spectrum. Fixed income is traditionally seen as a would-be casualty of inflation, but the likes of Treasury Inflation-Protected Securities (TIPS) and bank loans can buck this trend. Real assets, such as infrastructure and real estate, can serve as decent hedges, while the lengthy cycles that characterise commodities are also worth investigating. Equities could provide the most obvious answer for many investors.

Uncommon Truths: Central Banks in a Pickle asks whether central banks’ apparent policy of purchasing assets to prevent financial market instability can be pursued indefinitely. Here, too, the advent of inflation is considered – as are the prospect of worsening inequality and the likelihood that the normalisation of central banks’ balance sheets could take more than a century to accomplish. “If it seems too good to be true,” warn the authors, “then it probably is.”

Talk of central banks and money supply nowadays increasingly encompasses the possibility of digital currencies emerging as serious rivals to their conventional counterparts. Bitcoin – Currency of the Future or Speculative Asset? analyses the pros and cons of the foremost player on this stage, inferring that in this case the value of digitisation lies not in the asset itself but in the associated technology. To quote Invesco’s Chief Economist, John Greenwood: “We have yet to be convinced that bitcoin has intrinsic, long-term advantages over other asset classes.”

Flexibility, farsightedness and faith in the future

How might we express the Stockdale Paradox in simple, recognisable investment terms? One obvious framing, to hark back to an earlier observation, would be risk versus opportunity. Realism revolves around risks; optimism revolves around opportunities.

To identify opportunities, of course, it is necessary to be open-minded. Particularly today, as the world edges towards the light at the end of the COVID-19 tunnel, investors need to be flexible and willing to look further afield. Factor Investing in China offers a fascinating illustration.

China’s role in the global economy is widely tipped to become more significant than ever in the wake of the pandemic. This alone offers reason to investigate what the country might hold in store for factor investors. An uncommon blend of high liquidity, market inefficiency and regulatory idiosyncrasies may prove intriguing from the perspective of quantitative investing – notwithstanding that there will inevitably be some curves in the road.

It is worth noting that all the outputs referenced here underscore the importance of a “bigger picture” investment ethos. As argued in Rethinking Asset Allocation, obsessing over the here and now is seldom prudent. It pays both to look around and, crucially, to look ahead. What really matters, as James Stockdale appreciated, is how the story concludes.

None of this means that we can regard market cataclysms as ephemeral trivialities. They are still damaging and sometimes even devastating. But the best rule for recovering from losses is exactly the same as the best rule for seeking gains: stay invested.

Every investor’s journey begins with an assumption of a happy ending. As the past year has shown, it is usually only by doubting such an outcome that we truly endanger its realisation.

Disclaimer: The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment-making decision. As with all investments, there are associated inherent risks.

Selected thought-leadership outputs for Q1 2021

From Constraint to Catalyst: COVID-19, Technology and the Emergence of “Smart Relationships”

Martin Franc, CEO, Invesco Australia

John Galateria, Head of North American Institutional

Colin Fitzgerald, Head of Distribution, EMEA

Kevin Lyman, Director, Global Investment Initiatives

Published January 2021

Towards Smart Relationships

Colin Fitzgerald, Head of Distribution, EMEA

Published March 2021

Appetite for Change: Food, ESG and the Nexus of Nature

Cathrine de Coninck-Lopez, Global Head of ESG

Maria Lombardo, European Head of ESG Client Strategies

Dr Henning Stein, Global Head of Thought Leadership

Maria Lettini, Executive Director, FAIRR (Farm Animal Investment Risk and Return)

Published February 2021

Anticipating Inflation: Historical and Multi-Asset Perspectives

John Greenwood, Chief Economist

Duy Nguyen, CIO, Investment Solutions

Joe Rodriguez, CIO, Listed Real Assets

Scott Wolle, Head of Systematic and Factor Investing

Kevin Holt, CIO, US Value Equities

Rob Waldner, Chief Strategist, Head of Global Macro Research

Published February 2021

Uncommon Truths: Central Banks in a Pickle

Paul Jackson, Global Head of Asset Allocation Research

András Vig, Multi-Asset Strategist

Published February 2021

Bitcoin – Currency of the Future or Speculative Asset?

John Greenwood, Chief Economist

Adam Burton, Assistant Economist

Published February 2021

Factor Investing in China

Alexander Tavernaro, Senior Portfolio Manager, Invesco Quantitative Strategies

Andrew Tong, Senior Portfolio Manager, Invesco Quantitative Strategies

Published March 2021

Rethinking Asset Allocation

Dr Henning Stein, Global Head of Thought Leadership

Published January 2021