A Crisis of Confidence, but No Time to Panic

Rather than breathing a sigh of relief that the U.S. debt ceiling debate has been resolved, the markets have registered a precipitous decline. Then, adding insult to injury, the Standard and Poor’s ratings agency downgraded the credit rating of the U.S. Government. This has resulted in a further wave of selling in risk assets, and the purchasing (not selling) of U.S. government debt.

Despite the non-stop reporting of the reasons that markets are behaving so badly, there does not appear to be any “new” news. Nothing that has been offered as rationale should be any surprise to market participants. The Standard and Poor’s downgrade of U.S. debt was widely expected, the details of the debt ceiling debate are known, and the Euro debt concerns have been extensively covered for over a year. There are many worries and problems in the financial markets, but all of them have been known for some time.

We believe that the current market decline is a symptom of a crisis of confidence. There is enormous anxiety about global sovereign debt and the ineffectiveness that governments have shown in resolving their fiscal problems and reacting to events. Evidencing this position, Standard and Poor’s downgrade opinion said, in part, 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.’” Again, this is not really news, but this sort of political stalemate clearly detracts from investors’ confidence in the future.

The recent market activity reinforces the idea that in the short-term, financial markets are often driven by emotion.  In the long-term, however, market returns are driven by valuation, which is unquestionably more attractive after the recent market slide. It is likely that the emotion driving this current downturn is further intensified by the still vivid memory of the 2008-2009 market declines.

On a positive note, the economy is in much better condition than it was in 2008 and 2009. While we may have a slowly growing economy, we have successfully emerged from a very deep recession. GDP and corporate earnings have both exceeded peak levels set before the recession began. Both corporate and individual balance sheets have improved dramatically and the overall leverage in the financial system has been greatly reduced.

In addition, the slow recovery is due in large part to lingering weakness in employment and housing, making further sizable declines in these vital areas of the economy far less likely. Slower demand has also reduced the prospects for any near-term inflation and interest rates should remain extraordinarily low for the foreseeable future.

So, while we are concerned about the recent market declines, we still believe that each of our clients’ investment portfolios should be aligned for the long-term success of their goals and objectives. While it may sound like a broken record, we think this long-term perspective should guide investment policy. Further, we believe that the recent market decline presents an opportunity to rebalance our clients’ portfolios back into their strategic targets.

Please feel free to call if you would like to discuss this further or if there is any specific action you would like to take in your portfolio.

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