As the U.S. creeps closer and closer to potentially defaulting on its massive debt, we have been keeping a close eye on key market indicators and strategizing about how this may affect portfolios and our clients’ long term financial health.
Our base case scenario is that the negotiations – if you can call them that – go up to the eleventh hour, creating nervousness and uncertainty in the market. However, we think that the government will again kick the can down the road, temporarily increasing the debt limit and allowing us to pay interest on our debt. If this doesn’t happen, the government also has the ability to prioritize expenditures from tax revenues and it is very likely that interest on U.S. government debt will be one of those priorities.
An important consideration of the debt default situation is that it is binary in nature. We recognize that if the default happens, all asset classes will suffer. If it gets solved, we are likely to see a strong market rally, only it could happen so fast that anyone who got out will not be able to get back in to participate.
We recognize that this situation is historic. Already, approximately $2 billion has been shaved off the U.S. economy, as much as inflicted on our state of Colorado from the recent floods. Businesses big and small are feeling the pinch of the government shutdown – everyone from large government contractors like Lockheed Martin down to individuals who run hiking tours in the national parks. These are people who are not generating incomes and not contributing to the economy.
At BSW, managing different risks is what we do. We weigh what risks are worth taking (because we expect to be rewarded – as in stock risk), and what risks are not worth taking (for example concentration risk, i.e., putting all our eggs in one basket in hopes of “beating the market”). We do this risk analysis through long term lenses. When we construct portfolios, we are looking a year or more into the future and asking how we best navigate the road to get us from Point A to Point B.
With all this said, we are choosing to keep portfolios diversified and focused on an allocation that is appropriate for each individual client and their long term financial goals.
At the same time, BSW has recently been rebalancing portfolios – not in reaction to this situation, but because it is part of our disciplined investment management process. Since growth (stocks) has done very well year to date, we have been selling some stock positions and taken proceeds to cash. This cash will find its way to productive, income producing bonds in the near future. In the meantime, these funds are stable, secure, and have reduced overall portfolio risk. In addition, we have cut back on U.S. stocks and added more to select European equity opportunities, where we see more value.
We hope this speaks to concerns you may have about this issue and importantly, how we deal with these types of risks. Something tells us we’ll be watching this movie again.
–Craig Seidler, Senior Portfolio Manager