Business

Here is a lengthy checklist of dangers, and what is lacking is unsettling: Morning Temporary

Monday, December 4, 2020

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It’s the risks no one talks about that can do the most market damage

As investors think about where the stock market will head in the near future, they’re probably also thinking about what could go wrong.

In a new monthly survey, Deutsche Bank asked clients to identify what they “think are the biggest risks to the global financial markets in 2021.” The firm provided a list of options for respondents to select.

“Interestingly, all the vaccine-related concerns filled out the top 3 which may suggest that although consensus is for a good 2021, a successful vaccine roll out could still bring upside surprise relative to expectations,“ Deutsche Bank strategist Jim Reid observed on Friday.

It's the risks that investors aren't thinking about that often do the most damage in markets when they come into fruition. (Deutsche Bank)
It’s the risks that investors aren’t thinking about that often do the most damage in markets when they come into fruition. (Deutsche Bank)

Indeed, even though investors may be confident that something expected to happen will actually happen, the smallest amount of uncertainty will keep that eventual event from being fully priced into the market.

Conversely, you could also say that investors may be somewhat prepared for the items identified in the chart above to go wrong.

But what about the risks that weren’t surfaced here (or were considered by the <5% who responded to that question with “None of these”)?

Well, those unidentified risks are often characterized as being so unlikely that they probably aren’t worth giving too much thought.

Unfortunately, it’s those very unidentified risks that can do the most damage when they come into fruition. Consider 2020. Coming into this year, few could’ve even imagined that we’d face a global pandemic that would force large parts of the economy to grind to a halt. It’s this lack of expectation that leads this risk to be underpriced in the market, and therefore cause the stock market to crash like it did.

To be clear, we’re not suggesting that investors should start thinking of unlikely risks as though they were likely. If investors were always overly worried about everything that could go wrong, risky assets like stocks might never be cheap enough.

However, investors should understand that unexpected events do happen and the stock market does crash every once in a while.

The good news is that the stock market has a consistent track record of recovering steep losses and rallying to new records. And so, investors with time to invest shouldn’t avoid stocks for fear of the next crash, but be mindful that things could go wrong in the short-run and could present a buying opportunity.

By Sam Ro, managing editor. Follow him at @SamRo

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