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The environment in which we manage investment portfolios is becoming increasingly chaotic. Retail traders are a new force, we have daily jawboning from the Fed reassuring us that “all is well,” and we have nothing but positive Wall Street narratives.  Then we look at the actual data – both macroeconomic and fundamental.

The lockdown-induced recession and following stimulus have created a great deal of noise and confusion. A lot of indicators of activity have been ripping to the upside, and looking at surveys, the broad majority of investors expect that to continue.

I’m not so sure. While there are certainly some parts of the economy that look great, largely in the retail space, a lot of economic numbers, like industrial production and employment, are looking more questionable.

Where you dig for data also changes what you find. If you focus on what big companies are doing and what they are saying, then it looks better than if you focus on smaller companies. To me, this is problematic. While small companies as a whole don’t make a great deal of money, they do employ a lot of people and buy a wide range of products and services to maintain their businesses. I always remember one of the basic problems that Cisco ran into back in 2000 was that many of their smaller customers went out of business and they had far fewer companies to sell to. Are today’s customers also on the path of disappearing? Even the Fed has worried about trouble with the viability of small businesses.

Instead of going over of what could happen and trying to predict what is likely to happen, I want to focus on the central question: How do you invest in this chaotic environment?

Of course, there are multiple possible answers to that. You could YOLO (You Only Live Once) on the next hot tech stock IPO. Hey, lottery ticket stocks have worked remarkably well (at least in terms of price, if not profits), and maybe that continues. Conversely, you could invest in the global economic reopening, buying cyclical stocks.

The problem is that those ideas have already been worked over quite a bit. The big tech stocks haven’t broadly done much for several months, perhaps because people are starting to realize they are paying a higher than average valuation for slower than historical growth. And while you’d certainly think economic reopening will improve the outlook for cyclical companies, many of them have already gone up triple digits and are priced for a practically perfect future.

What I’m focusing on is companies that aren’t participating in some wild ride. For instance, defense companies seemed to get a fair amount of pork from the last rounds of stimulus, but aren’t priced high at all. Similarly, there are boring food and drug stocks that have pretty reasonable prices.

Could those stocks go lower? Absolutely, but at least you can see the floor. Particularly in Small Cap we are invested in some more growth oriented names, and it’s amazing how many stocks are out there with a huge potential price range, depending on how things work out. To take one that’s in the news a lot of late, I think you can make a reasonable case for GameStop (GME) to be worth $10 or $100. Part of that is how aggressively investors are willing to anticipate potential growth. Tell a happy story, get people excited, and your shares may double. What’s the next Amazon worth? I think that’s a surprisingly tricky question for any “next Amazon,” but people want to hit that buy button instead of thinking about the range of possibilities.

And to me, that’s the basic problem. Citigroup, among others, has indicated that this is the most euphoric investors have ever been, going back decades. To me, that’s scary. People were euphoric in 2000 and 2008. They thought the music would never stop. Then it did.

What pops this bubble? Rates? Disappointing economic growth? I think it’s really hard to say. Honestly, the numbers haven’t mattered much in this environment, as it’s all about sentiment. That’s not just a tech thing, either. For instance, oil inventories last week, to me, were bad news. Gasoline demand wasn’t there. People shrugged, blamed Texas, and moved on.

This has created what seems to me to be the most reflexive market I’ve ever seen, where subjective perceptions influence reality until the perceptions are so far detached from reality that a reversal is eventually inevitable. People decide something, like for instance that oil demand will soar. They buy oil futures betting oil will get to $50. Other people see that, get excited, and start betting oil will get to $60 by making even more aggressive assumptions, and oil starts going up even more. Soon other people see where this reflexive bullish cycle is going to end up and start betting on $100 oil. That’s the market we have now. Reflexive gamblers seem more important than hard data.

At some point, that will end badly. But I don’t know when. Maybe it ends in pieces. For instance, ARKK funds have become huge with some truly big bets. As they get so large, having so many volatile, relatively illiquid names is really dangerous. If they start seeing more investor outflows, what will that do to their holdings, particularly if other investors know the situation? If TSLA, their largest holding, starts going down, what does that do to Tesla’s ability to conduct business on the friendly terms they’ve had? Will that impact Bitcoin, as Tesla may not be eager to buy more if they’re under greater stress? This strikes me as a scary time to buy some of these high growth stocks. Reflexivity can be great on the way up, but pretty horrible on the way down.

Similarly, what if the economic reopening doesn’t meet what seems like Wall Street’s high expectations of a strong recovery? How might that surprise affect interest rates, inflation, the Fed’s QE purchases of financial assets, government stimulus programs, consumer staples vs. consumer discretionary stocks, utilities vs. tech and cyclicals, and precious metals?

At this point in the chaos, I’d rather focus on what seems like less risky options. In this market, I’m not sure anything is safe, but I’d mostly rather focus on stocks that have 30% likely ranges rather than 300% likely ranges.  At times, at least thinking about preservation of capital and managing the big events matters a lot in managing investment portfolios.