Two years ago I attempted to run the Leadville 100 Trail Run with very little training at altitude. For a sea-level, warm-weather, flatlander like me, the outcome of running on cold, 10,000-feet-high, steep and uneven mountain terrain with little acclimation was predictable. An experienced ultra-runner with many “100s” under my well-worn soles, I still fell behind my planned schedule and had to drop out two-thirds of the way in (this was only the second time in over 50 races that I have had to drop). The key, as it became clear, was to get used to the primary variable that was different — altitude — and the consequent lack of oxygen. It brought the importance of specific training for altitude into painful sharp focus.
Last weekend I took care of the unfinished business, and got the monkey off my back. I returned to Leadville with the singular goal of completing the race comfortably and got it done – no heroics, no drama, no stress… just a comfortable finish due to good preparation for the one factor that mattered. Of the 680 starters, 324 finished (47.6%). And this time, the main difference was that I made it a point to get to 10,000 feet almost two weeks in advance to let my body get used to the lack of oxygen. I fed the body what it needed – high iron content food, water, lots of rest, etc. so it could make more red blood cells. Within a week my blood oxygenation level rose from 85% to almost 95%, and more important it stabilized, a big difference from the wild volatility in the concentration when I first got there (see picture below). Still not 100% like it is at sea level, but good enough to feel more or less at home even at 14,400 feet on Mount Elbert, the highest peak in Colorado and second highest in the lower 48 states.
Over the last decade and a half or more, investors have gotten to their own version of easy sea level conditions. Liquidity has been plentiful and central banks have supported markets and economies. The twenty five trillion dollars or so of money printing and credit extension just in the last few years has therefore resulted in economies and markets being unprepared for their version of high altitude exposure: a gradual reduction in liquidity. The Fed is buying about four billion of assets daily, and the risk markets are seeing about the same amount of inflows daily (Source: Federal Reserve, Goldman Sachs). Coincidence?
Starting tomorrow morning, various central bank speakers and economists will start to express their views about asset purchases, cheap money, and the expanding responsibility of monetary policy to make up for fiscal policy shortfalls. This happens annually at the Jackson Hole conference organized by the Kansas City Fed and this year is about policy in an uneven economy (agenda). But given that investors are generally not acclimated to the absence of government support of markets, central bankers will have to choose their words very carefully. Any talk of asset purchases that seems tone deaf to the market can quickly result in panic for a market habituated to government support. And from current levels in asset markets, the speed and depth of the fall can be sharp and precipitous, which obviously they will have to mop up, yet again.
When running a difficult race in unfamiliar and potentially volatile and uneven conditions, every long distance runner knows the key to success is to maintain a very fine balance between running too fast, which results in prematurely burning up stores of energy, or running too slow, which results in missing cutoffs (and embarrassment for losing to the guy in the Elmo suit). Pacing is critical. For central bankers, the task is similar, as they plan the unwind of an unprecedented era of easy policy. Taper or tighten too fast, and a market crash – or “taper tantrum” — can result, which can reverse the gains in investor psychology of last year. On the other hand, going too slow can result in big asset bubbles that pop, misallocation of resources, and inflation, which can sow the seeds of a cycle of increasingly market unfriendly policies.
Runners, faced with the two choices, build some cushion by running just as fast as needed to have enough room for unforeseen error, but not too fast to “blow” themselves up. This is the runner’s version of building optionality by allowing for a wider range of choices if reality is not going according to plan. The cushion allows the runner to have some reserve for the unforeseen periods. And this reserve is what allows them to speed up toward the finish line.
With volatility levels skimming multi-decadal lows, investors not accustomed to a sudden withdrawal of extremely liquid conditions should pay close attention to the cheap cost of hedging. Whether it is melt-ups or melt-downs that are in the cards, faced with conditions that have not been observed for almost two decades, investors can benefit today by sacrificing a small amount of prospective return to make their portfolios more robust for their version of sudden oxygen deprivation, i.e. a sharper than expected withdrawal of liquidity. Central banks can make pacing mistakes, like the rest of us. And yes, there are many other factors that will drive markets; but as I found out, focusing on the one factor that can pose the most risk to the plan, and acclimating to it, is the best way to turn potential disaster into a manageable situation.