Talk of government shutdowns are scary and the hype from the media doesn’t make it any better. The truth is that government shutdowns have been a part of our past. They usually don’t last long as the pressure from business leaders, constituents, and more reasonable politicians start to weigh on those causing the impasse. NBC came out with a chart that shows there have been 17 government shutdowns since 1976:
A couple things to note here. First, shutdowns are not all that uncommon. Second, they don’t last very long. Most of the time it is just a few days. The longest shutdown over the past 40 years lasted 21 days back in 1995. Could this time be different? Sure, but the idea of a protracted government shutdown seems unlikely if history is any guide.
One of the bear cases for the US stock market is that profit margins (the percentage of sales a company earns after it pays all its expenses) are at all time highs and therefore, when these margins revert back to their mean, corporate earnings will fall (and with it, the stock market). We’ve written about this concern in the past and have avoided making any rash investment decisions based the possibility of this occurring. This inaction has proven to be the correct strategy thus far as US equity markets are still near all-time highs.
Fortune has a very interesting article that puts this topic in a different light. While most commentators who are warning on this profit margin problem are using profits as a percentage of GDP, profit margins of the S&P 500, don’t look nearly as bad. Here is a chart from the article:
When looking at profit margins in this light, they look pretty typical of other recoveries. This tells us that the impending doom of profit margin compression may not be as bad as some would have you believe. This is especially true with the largest companies in the US, which make up the largest component of most investors portfolios.
It seems like the looming government shutdown and debt ceiling showdown is all the media can talk about. Rightfully so, it is a big deal if they can’t come to any sort of compromise. Interestingly, the political groups in Washington are pounding the table about this threat while Wall Street just isn’t buying it. The market has shown tremendous resilience with the S&P 500 up over 2.5% in the past month. In addition, the VIX, a metric many people call the “fear index” continues to show no concern. Here is a chart over the last month:
So what should we make of this? Who is right? That remains to be seen, but we do have some sort of playbook to go off of since we have faced government shutdown and debt ceiling fights over the past several years. If the past is any indication of how this could play out, don’t expect any resolution until the 11th hour. As a firm, we feel much more comfortable believing what the market is doing versus what the politicians are saying, so we are refraining from taking any action with client portfolios. While it may not be pleasant over the coming weeks, we believe we will get to the other side of this showdown. Unfortunately, it seems as if these minor disruptions could become the norm given the political climate and the fact that these debt ceiling and government funding votes happen relatively frequently.
I’m going to let you in on one of Wall Street’s dirty little secrets. It is probably one you’ve known deep down, but never really had any data or research to prove it. Financial advisors offer no value in helping you choose funds that will outperform. Here is a quote from an article in the Financial Times on the topic:
On an equal-weighted basis, US equity funds recommended by consultants underperformed other funds by 1.1 per cent a year between 1999 and 2011, according to analysis of 29 consultancies accounting for more than 90 per cent of the market by a team from Oxford university’s Saïd Business School.
“The enormous power wielded by consultants is not matched by their performance,” said Jose Martinez, one of the authors of the study.
“In US equities, one of the largest asset classes, investment consultants as an industry appear to add no value in fund selection,” added co-author Howard Jones.
Investment consultants in this business will analyze things like alpha, beta, standard deviation, up market capture ratios and past performance to tell you who you should be selecting for your large cap equity manager. The thing is not one of those variables actually matters, and there are no factors (outside of costs) that have any predictive ability in determining future performance. So, why should anyone even consider working with a financial advisor if they can’t add value by selecting future winners? I have listed three major reasons below (none of which have to do with predicting the future):
- Financial planning- a good advisor will help you determine a clear path forward by organizing your financial life, articulating your goals, developing a plan of action, and reviewing the progress. This would include not only your investments, but your long-term retirement plan, tax minimization strategies, cash flow planning, risk management and estate planning.
- Behavior management- investing is hard. Investing is emotional, especially when it is your own money. A good financial advisor will help to keep you grounded in times when greed is running rampant, and will lend long-term perspective when it seems like the world is coming to an end. Good advisors help clients manage their emotions, which is one of the major stumbling blocks of a successful long-term plan.
- Allocation of assets- while many advisors think they should be focused on picking great stocks or funds, the research shows that how a client allocates their assets is going to be the greatest determinant on risk and return. A good advisor will help a client develop a long-term investment policy and stick with the plan through good times and bad.
As you can see, none of the points above have anything to do with trying to predict the market or how a manager will perform in the future. Be wary of anyone who makes a claim that they can predict something that is unknowable.
In reading articles about the bond market and its ongoing collapse, you would think people have lost a fortune. Here is a quote from an article I just read:
“The year 2013 looks on track to become the worst US bond market in 40 years,” wrote JP Morgan analysts in a recent research note.
Wow, that sounds pretty bad. What this doesn’t reflect is the extent of the losses. So far this year, the Barclays Aggregate Bond Index is down 3% this year. That’s right 3%. This is interesting on two fronts:
- This is not really that bad. The stock market lost 57% of its value from its peak in 2007 to its trough in 2009. During that period, it wasn’t uncommon for the stock market to lose 3% in a DAY, so we really do need to put this in perspective. More than anything, this tells us just how good the bond market has been for the past 40 years.
- The chance for greater losses is high. Bonds lose value when interest rates rise. With the 10 year treasury bond still under 3%, there is a good chance that an improving economy will cause interest rates to creep higher. If that were to happen people are going to opine about the good ole’ days when they only lost 3% in their bond funds.
None of this means people should just abandon bonds. The fact that a bad return is -3% shows just how safe certain types of bonds can be. They are still a great diversifier, risk dampener, and income source for a portfolio. The most important decision you can make as an investor is just how much of this asset class should be in your portfolio.
Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.