By Matthew T. Skaves, CFA
Let’s look on the bright side; the grueling, nasty, divisive election cycle has come to an end. Yes, stock markets are down significantly today, meaning it’s easy to assume investors are unhappy with President Obama’s reelection. However, proximity doesn’t necessarily prove causality, and we challenge this assumption, at least in part.
First and foremost, our country faces problems that transcend one man, one branch of government, or one election. Both major parties, and all branches of government, are to blame for the irresponsible lack of foresight and compromise that has driven us toward the brink of a $600 billion fiscal cliff. Regardless of who sits in the Oval Office, our nation’s long-term fiscal woes will only be addressed when elected officials realize that compromise, not partisanship, is the way to govern a nation of diverse peoples.
Financial markets doubt our politicians’ willingness to compromise, and this is part of the reason why stocks have fallen. Now that the election is over and the promise-laden fog of 24/7 campaigning has lifted, investors are left with the cold, hard realization that very little has changed and work still has to get done. As a nation, we’ve been like high school students watching a fantastically gory monster movie the night before our mid-term paper is due. Now the movie is over, and the “Oh crap” feeling of procrastination has set in. It’s not so much that we disliked how the movie ended.
But to get closer to the heart of the matter, why do markets go up or down? At the end of the day, it’s because of valuation. We argued in our most recent quarterly commentary that markets are fairly valued or perhaps even slightly overvalued. In fact, stock prices have been declining, more or less, since mid-September, because valuations can only rise so quickly in a tepid economy. Take away the presidential election and we’re still left with high unemployment, slow growth, and the European debt crisis. These are all catalysts for a market pullback. Just today, over 80,000 Greeks gathered outside of parliament to demonstrate, not so peacefully, against austerity measures. This would have rattled markets on its own.
We’re not bullish, and we haven’t been for a while. So, if you’re worried about declining markets, you’re more protected than you might think. Portfolios continue to be conservatively tilted, and we’ve been taking steps over the past several months to reduce risk. In August, we started reducing equity allocations for our moderate and conservative clients. Now, we are reducing exposure to credit-sensitive bonds, which have seen significant price appreciation.
However, we’re also not clairvoyant, and we recognize that our timing is not always perfect. That’s why we make our changes in measured, deliberate steps. What if we’re wrong, and stocks rebound sharply? We don’t want to be out of the game entirely. We want to protect on the downside but participate on the upside. The only way to do this is to implement disciplined, broadly-diversified, global portfolios built on long-term, strategic game plans. Sure, we will make tactical changes on a play-by-play basis, just as we have recently with stocks and high yield bonds. But a good coach won’t change his entire game plan simply as the result of a fumble or an incomplete pass. We therefore strongly advise against large portfolio changes in response to one election or one day in the market.
In the aftermath of a truly negative campaign season, it’s easy to remain caught-up in the doom and gloom. However, our nation was founded upon a common vision of hope and prosperity. At Deighan, we choose to keep this vision in our hearts and minds, as we remain cautiously optimistic that compromise and bi-partisanship will define the coming four years. At the same time, optimism alone is insufficient. We are pragmatic enough to realize that our clients’ portfolios face significant challenges, which require a conservative, measured approach.
As always, we welcome any questions or concerns you might have and truly appreciate the trust you’ve placed in us.