The Butterfly Effect
Small changes can have major repercussions. Chaos theory describes the metaphor of a butterfly flapping its wings, resulting in a cascade of events that ultimately leads to a tornado weeks later. A microscopic virus can also make fools of all our predictions:
The above is from AllianceBernstein’s global macro outlook from February of 2020. Needless to say, the forecast underestimated the impact of the coronavirus. At the time, it probably was a reasonable set of educated guesses, but the coronavirus epitomizes the perils inherent in attempting to predict the unpredictable.
The last bullet point, referring to the balance of risks, does provide a useful framework for portfolio construction. Investing by its nature encompasses a degree of risk. Diversification helps shield portfolios from events that affect a narrow subset of economic sectors or regions. For broader shocks, such as 2022’s downturn in both equities and fixed income, significant losses may be difficult to avoid. There are probably very few individuals who predicted that the last 4 years would bring about a global pandemic, massive government stimulus, supply chain shocks, a sharp rise in inflation, a record-setting pace of rate hikes by the Fed, and a large drop in inflation that is starting to approach the 2% target. A portfolio diversified across sectors, countries, and investment categories is broad-based and less likely to depend on making correct calls on particular regions or market segments. Covid provides a vivid illustration of the massive gap we sometimes witness between foresight and hindsight.
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This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument or investment strategy. This material has been prepared for informational purposes only, and is not intended to be or interpreted as a recommendation. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice.