What to do as Shutdown lingers..10/16/2013

Just want to assure our clients that I am paying close attention to the unfolding budget/debt drama and am ready to recommend and take action as necessary and appropriate to manage your investments according our clients’ goals and objectives.   As always, I stand ready to answer questions, process transactions, and put forth best efforts to manage portfolios with the same dedication, diligence, skill and judgment demonstrated over the past several years.

You will recall my repeated observation that investors always have one of three choices in response to external factors—buy, sell or hold. Hold is another word for “do nothing” or “stay the course”.  Since 2011 you will note that I have advised the best course of action is “be cautious” and for the most part “stay the course” during this period of “stormy weather”.  So far, that has proved to be good advice. I firmly believe it is still the right advice today.

Despite the media “hype” and “public despair” and predicted doom from a government “default”, today (10/16/2013) the S&P500 reached a near all time high on “hope” of an uncertain “deal” to end the current crisis. Why is the market up during all this? 

First, markets expect a “kick the can down the road” temporary truce---i.e. more of the same. US Treasuries are still expected to be the most safe and liquid investments in the world—for the most part, competing securities are still seen as more risky. China, Japan, and Germany all need a place to invest the money they earn from exporting to the US—either US Treasuries, US Corporate Bonds, US Real Estate—or US Equities. Actions that make US Treasuries look less attractive may actually make US Equities rise in value.

Second, markets expect that the Fed will “do what it takes” to continue the stimulus needed to inflate stock and real estate prices—i.e. more of the same.

As strange as it may seem, markets like “more of the same”---change or a fear of change is what causes markets to fall.

So what to do?

Since you are a long term investor and not a gambler---no action is recommended to anticipate any deal or lack of a deal. Predicting an uncertain outcome is like picking the winner of a horse race—it is gambling.  Markets could suffer a brief panic and a significant decline (maybe back to early 2013 levels) over an unexpected delay in reaching an “deal” but history teaches they will recover quickly.  In this case, our recommended reaction to a down market would probably be to increase ownership of equities—but let’s wait and see.

P.S. About the politics of all this….

The Media reports that Republicans have lost a lot of support because of this shutdown. Yet, it is doubtful that this will change the outcome of House elections in 2014.  Few regular voters are unhappy with their own representative despite some “throw them all out” polls. The most recent Gallup poll shows the leader of the House (Republican Boehner) and the leader of the Senate (Democrat Reid) tied with a low 27% “favorable” rating. The President seems to have done better, maintaining a 49% “favorable” rating.  There is a philosophical war going on in Washington. It used to be a just a struggle about how Big Government would spend our money along with whether deficits would be funded with increasing taxes or increasing borrowing.  There is now a strong and growing group who want the federal government to get smaller—a lot smaller. (The Tea Party is only a small part of the "we want smaller government" group. The larger and underestimated group is probably the Evangelical Christians that are less vocal but still irritated by the actions of a large "secularized" central government.) They really don't like the traditional Republican program any more than they like the Democrat's program. This group sees the present course of deficit spending leading to a catastrophe and they believe that raising taxes to cut the deficit would also end in catastrophe. (An analogy would be the actions of the passengers on the Titanic if 20% of them had been absolutely sure that the ship was headed for an iceberg.)  I don’t see this group “surrendering” so I would predict continued and perhaps even increasing turmoil in Washington----and I predict that markets will adapt to this new uncertain environment. Perhaps they already have. I also predict that the most likely future is that bond markets will force government spending to be cut and taxes to be raised—this will occur when interest rates rise significantly from present low levels.