In January, markets increased. International stocks fared the best, followed by US large and small caps. Bonds trailed, but still made money.
Thoughts on Risk
“Risk is what’s left over when you think you’ve thought of everything.”
- Morgan Housel, author of The Psychology of Money
One of the most fundamental investment concepts is the connection between risk and return. Most investors understand that in order to achieve higher returns, they must be willing to take on higher risks. Higher risks can mean uncertainty and volatility. However, not all risks are created equal. Consider the following aspects of risk:
Known vs Unknown – Paradoxically, awareness of risk reduces it. Take skydiving for example. It seems risky: you’re jumping out of an airplane! But, because of the inherent risks, many safety precautions are in place and very few accidents occur. Or, consider driving in an Ohio winter. If you know the roads are snowy, you are much more likely to drive carefully. Financial markets work the same way. Known risks – like political elections or movements in interest rates – tend to have limited impact on stocks because they are scheduled. On the other hand, unknown risks can have a big impact.
- For example, last week, a Chinese AI startup called DeepSeek released the most recent version of its AI model. It allegedly uses far fewer semiconductors and runs far more efficiently than US-based products like ChatGPT, Gemini, or Claude. No one was paying attention to DeepSeek – this news came out of nowhere. Because of this, markets had a big negative reaction.
- o This morning, markets are digesting news regarding President Trump’s tariffs. While markets have been somewhat aware of this risk since the election, the details and severity have been unclear. Markets are reacting to this news initially but as details emerge, risks are likely to become more known and markets will settle accordingly.
Markets Move Quickly – Stocks change in value at lightning speed in response to new information. Markets also discern which investments are most impacted by news. Here are the returns of certain investments the day after the DeepSeek news became public:
- As you can see, certain semiconductor stocks were hit hard, others less so, and some stocks increased. Markets discerned which stocks were most affected, which were not, and moved accordingly.
Always Looking Forward – The Super Bowl will be played on Sunday, February 9th. By far, it’s the biggest football game of the year, accompanied with weeks of fanfare and festivities. But almost as soon as the game ends, pundits and prognosticators will start debating which team will win it next year. Financial markets behave similarly. DeepSeek is now public knowledge. Where markets move from this point will be based on new developments and information. In other words: risk can change from unknown to known very quickly.
As your advisor, we spend a lot of time thinking about the nature of risk and how to best approach and interact with it. If you would like to discuss this further, please let me know.
