Force majeure, a clause in legal contracts that exempts parties from liability due to unforeseeable and unavoidable catastrophes, can also apply to investing. Force majeure specifically is written into contracts to protect parties from the unexpected and from events that cannot be predicted — for example, if you’re building a house and an earthquake hits and destroys the foundation, setting back your timeline, the force majeure clause would protect your builder because the earthquake was beyond their control.
Although it may seem unrelated, being aware of sudden market shifts is crucial for investors. Trying to predict every possible outcome is impractical due to the role of uncertainty in investing. Instead, investors analyze large amounts of data to make long-term decisions. However, unforeseeable events and rapidly changing information can pose challenges that require quick adjustments. Here are two recent examples that illustrate this point.
COVID-19 as an Example of Force Majeure
The emergence of COVID-19 is a classic example of force majeure's effect on investments. In early 2020, economic indicators were positive, and unemployment was low. However, the outbreak of COVID-19, which started as a flulike illness, was initially disregarded by many. It eventually escalated into a global pandemic, resulting in the fastest bear market on record.
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The COVID-19 outbreak was an unforeseeable and uncontrollable force majeure event. Expecting an ideal investment strategy to counter its effects was impractical. Instead, investors had to adjust their plans based on emerging data and adapt to the rapidly changing circumstances.
Hyperinflation and the Housing Crisis as Force Majeure
An example of unpredictability in investing is the hyperinflationary environment that occurred last year. Despite claims from some analysts that it could have been predicted, let's revisit the third and fourth quarters of 2021. Inflation was gradually increasing to 5% to 6%, and many economists considered it to be transitory or short-lived.
Even the Federal Reserve, composed of some of the brightest financial minds worldwide, believed that inflation was transitory, with plans to increase interest rates three times in 2022 for a total of 0.75%. However, the Fed eventually raised rates seven times, resulting in a total increase of 4.75%, which was significantly different from their original plans. This event was another example of force majeure, where unpredictability played a significant role.
These instances serve as reminders of the sudden shifts in the stock market, which can be difficult to anticipate. While they may seem clear in hindsight, predicting them in the moment can be a challenge. One unexpected event has the potential to surprise everyone, leading to unpredictability. This can result in a complete restructuring of asset pricing, expectations and requiring investors to make adjustments.
The 2008 housing crisis is another example of this unpredictability, as investors believed mortgage-backed securities were secure investments until they were exposed as unreliable and misrepresented.
How to Combat Force Majeure
A strong investment strategy can help investors combat the impact of force majeure. It may help to work with a financial adviser as they often have knowledge, experience and resources at their disposal.
While it's impossible to predict the future, a good financial adviser, ideally one with an investment team, will start by developing a consistent and adaptable investment philosophy. They will then meticulously analyze large amounts of data to create a plan of action. Using historical data, they will determine how to make appropriate adjustments to their strategy to best tackle new and unforeseeable market changes. Lastly, they will act quickly to take advantage of new opportunities and stay ahead of any potential risks.
If you don’t have an adviser yourself, you’ll need to devise your own investment strategy that you’ll stick to — having your own investment strategy will help you to guide yourself when investing so that market ups and downs don’t distract you from your long-term goals.
When making your own investment strategy, think through your long-term goals, your short-term goals, your risk tolerance and your own needs both now and in the future. While you likely won’t have the same data that an investment team or financial adviser will, you can still research different funds and managers to see what fits best into your plan.
And you don’t have to do it yourself — there are in-between options, such as hiring a robo-adviser, even if you won’t get the same level of service as you would with a full financial adviser.
Disclosure: Diversified, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the SEC. A copy of Diversified’s current written disclosure brochure which discusses, among other things, the firm’s business practices, services and fees, is available through the SEC’s website at: www.adviserinfo.sec.gov. Investments in securities involve risk, including the possible loss of principal. The information on this website is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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