Is it okay to panic now? –No!
In the wake of the Standard & Poor’s (S&P) credit downgrade of the United States debt obligations (our bonds, bills, and notes that are owed to investors both domestically and globally), there is an abundance of interest, debate, and concern about what should be done. The media once again is filled with stories of impending doom. While we are all pondering what actions we should take, the media provides us with a simple answer – panic. Oak Wealth Advisors believes otherwise and wants to provide you with a more balanced approach to this unsettling time in the investment markets.
In order to evaluate appropriate actions to be taken, we must first understand the problem. The ballooning federal deficit and increasing expenditures are not being adequately supported by the tax revenues being collected by the federal government. The result of this financial imbalance is that the government needed to approve raising the debt ceiling in order to pay all of our bills and make the payments on our debt obligations.
There are a small number of rating agencies, including S&P, which were properly criticized for their lack of due diligence in rating the securities that led to the 2008 recession. Working to restore their credibility, S&P and other firms alerted the government that they wanted to see increased fiscal responsibility including a plan to lower the deficit. When the government passed the Budget Control Act of 2011, S&P determined that the U.S. had not done enough to justify maintaining their AAA credit rating.
Politics played a key role in getting us into this mess. In S&P’s explanation for their downgrade, it is clear upon whom they are putting the blame. “Our lowering of the rating was prompted by our view on the rising public debt burden and our perception of greater policy making uncertainty… Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a ‘AAA’ rating.”
This problem will not be resolved by throwing more capital into the system as we did in 2008 to turn the tide against the recession triggered by the meltdown in the financial services sector of the market. Politicians need to make hard decisions that will make it more challenging for them to be re-elected. Only time will tell if they will put the interests of their country ahead of their personal agendas and those of the supporters who line their pockets. I do not have a high level of confidence that the politicians will act soon to both cut entitlement spending and raise taxes. Most credible economists agree that both actions must be taken to improve the financial stability of the country and restore confidence in the promises made by our government.
Working from the assumption that the credit downgrade is unlikely to be reversed in the next six to twelve months, our attention turns to responses to the situation. It is always difficult to be precise about the timing and size of market movements and we know that the penalties for trying to time the market as well as sitting on cash are harsh. PIMCO, the world’s largest bond manager, eloquently states, “these are markets where you do not want to be forced to transact unless there is a changed view of fundamentals or emergency cash needs to be raised. Instead the key is to have the ability to react to exceptional opportunities.”
In practice, Oak Wealth Advisors will continue to invest portfolios according to the individual investment policy statements that you developed with us and we agreed were in your best long-term interest.
We will not be in a hurry to invest new cash as falling security prices are normally a good time to demonstrate patience. While the falling prices are creating more attractive valuations at which to invest new cash, we are keeping the analogy of the falling knife in mind at all times. That is, the safest way to catch a falling knife is to wait for it to hit the floor and then pick it up. We may not buy new securities at the absolute bottom of this current market sell-off, but we expect to be able to make some portfolio additions in most accounts at attractive levels in the coming days and weeks.
While it may be hard to envision a time when better investment returns will reappear, they may be arriving in the near future. Canada lost its AAA debt rating in April 1993 (it has since regained its AAA status). The Canadian stock market rose more than 15% in the twelve months that followed the downgrade. In Japan, the Tokyo stock market rose more than 25% after their downgrade was issued in November 1998. As you ponder the United States’ credit worthiness relative to its peers, the following chart from S&P may give you some comfort that we are still among the most financially secure nations in the world.
I encourage you to visit our website www.oakwealth.com and read the Deep Rooted Thoughts article from March of 2009 which illustrates the tremendous performance of the stock market following the worst economic news. After the stock markets bottomed in March of 2009, they rebounded significantly over the next twenty-four months. While we cannot know what the stock markets will do over the next twelve to twenty four months following the U.S. debt downgrade, we should assume that the markets will remain volatile and investors who do not panic will be rewarded.
Patience and discipline with respect to your investments are recommendations that you will rarely hear espoused in the media, despite the fact that they are key elements to long-term wealth creation and preservation. Oak Wealth Advisors acknowledges that we have no control over the markets nor do we possess a crystal ball with which to forecast the future. However, we are constantly evaluating ways to protect principal and invest in securities that offer attractive risk-adjusted return opportunities.