Everyone must wrestle with so many issues with regards to managing a portfolio. Should you liquidate some or all of the positions and stay out risking a “melt up” if a deal occurs? Do you buy in because prices are getting cheaper? How do you factor in the upcoming quarterly earnings announcements and their view of the future which may change as the situation in Washington unfolds? What about the Federal Reserve? Are they going to stop tapering or are they going to continue well into 2014 and beyond? As you can see, there are a great deal of “unknowns” to deal with yet we have some historical guideposts which may or may not help us navigate the investing dilemma at this time.
Between 1976 through 2005, there had been 17 governmental shutdowns. The net cumulative effect on the market was nearly zero! So this lends credence that in time while the market may be nerve racking right now, the reality is that the end results could be negligible. However, if it was just the government shutdown causing the market to decline, we would all be buying at a rapid pace.
The next data point to consider is to look at what happens when you have two very strong willed political forces going against each other. (You may think one side is right and the other is wrong, but history has shown that both sides are usually wrong.) In August of 2011 we went through this same process and it caused the US debt rating to be downgraded. Despite that, the bond market rallied while the stock market dropped 18% in less than 2 months (Please remember that we were also dealing with the European crisis as well, so some of the negative effect was a result of those issues). Excluding the Europeans for a moment, you may come to the conclusion that this gives you a reason to sell everything and “go to the sidelines” for a while. This may be the right course, but is it?
A similar disaster was staring us in the face after the November 2012 election. The news media was screaming about the fiscal cliff and the sequester. It made you think that this could be August 2011 all over again. Then suddenly out of the blue there was a deal, sequester took hold with limited impact and the market was off to the races. All of the fear being espoused was for naught. Yet, the potential of a massive downturn in the economy was real and something to be concerned with.
Fast forward to May of this year. Bernanke began chatting about tapering (i.e. cutting back on the amount of purchases that would be made on a monthly basis) and the bond and stock markets soon began to swoon. The sheer nervousness of the potential for rising rates and the probability of a weak economy standing on its own two feet made many nervous. This uneasiness caused the Fed to back off of their call to taper for the foreseeable future. A few Federal Reserve Board members are calling for it to begin this month or by the end of the year. But can this really happen?
Conventional wisdom would suggest that the Federal Reserve will begin to taper later this year or the beginning of next year. However, there is a strong possibility that they will not be able to begin the process until late-2014 or even into late-2015. The Fed has said they are data dependent but as the last five years have shown us, the current economic situation is uneven and not really creating enough jobs to take the slack out of the economy.
Now we enter earnings season. This will become very interesting as the reported earnings may be decent but the future projections might shed some real light on the economy. However, what is most concerning about the earnings is that the top line or sales growth has been anemic for five years. Demand comes and goes and when you feel there is a turn the corner moment, then trend reverses. So what really needs to happen is we need demand and there appears to be some of that occurring in Europe and parts of South East Asia.
So where does this leave us to manage a portfolio? Again, conventional wisdom would make one think that the best approach is to sell everything and move to the sidelines. However, no one knows how this is going to end and if there is some major headway, we could be buying into the market at substantially higher prices.
In addition, should the market continue to decline, it would be better to add or build positions in anticipation of the market to rebound and head higher as we approach the end of the year / beginning of next year? Building on that thought, the number of individual equity positions within a portfolio may expand going forward by purchasing smaller dollar amounts of more positions to diversify and potentially increase the probability of success.
An intention to limit the number of issues might be prudent, but after careful consideration and additional research, spreading the risk over more issues or make multiple purchases in smaller increments of a particular issue, may help the performance of the equity portion of an account. The goal is to do the best to deploy your capital in what we are the best prospects for growth going forward.
Tom is the Founder of TRG and has been the President and Chief Investment Officer since 2008.