Our recent investment snapshot posed this question: “Is the current economic crisis a ‘soft patch’ or the beginning of a double-dip recession?” I’m starting to wonder if we aren’t instead in a mud puddle. I recently heard this term used to describe the space between soft patch and recession, and it resonated with me.
In short, our economic outlook is messy – muddy, in fact. Yesterday’s stock market response showed some of the pent-up concern and frustration with our political circus, our persistently stuck unemployment, and the slow (or absent) economic growth that is lingering like a fog over any sense of confidence.
Is this “Groundhog Day” as it relates to the recessionary period starting in 2008? Are we heading back towards a repeat of that time frame? I really don’t think so, primarily because the backdrop is different this time around. The consumer has taken steps to deleverage and in fact is saving more; businesses have gotten leaner and are generating decent levels of cash flow; and economic indicators including auto sales, home starts, and unemployment are already hovering near their lows. It doesn’t mean they won’t move lower, but our economic dashboard is already anemic and that isn’t news. (One important caveat: the European debt crisis could continue to have material global effects.)
Objectively, equity valuations are below historical averages on a price to earnings basis, and the earnings yield (inverse of the P/E ratio) is trending well above 10-year Treasury rates. This is something even Warren Buffett likes to see! When compared to other investment alternatives, including negative real rates of return on money market funds, growth assets should not be arbitrarily put in the dog house.
I have found that one healthy way to look at your portfolio is to use the following exercise: assume that your portfolio is sitting in cash today instead of the current positions you may hold. Then, look at all of your possible investment alternatives from a risk and return standpoint and ask yourself how you would you allocate the money if you had to right now. Many times investors can get anchored to their existing holdings too strongly, especially when viewed through the lens of trading costs, unrealized gains/losses, and taxes. If you try to position your portfolio using the approach above, you can minimize the emotional challenges of making investment decisions.
So, here are a few investment keys for working through this financial mud puddle while keeping you moving towards your goals:
1. Focus on fundamentals more than you focus on the news—now is the time to hone in on the facts and not get blown around by the ever increasing list of “experts” espousing fear (in most cases.)
2. Stay agnostic about the investment choices you have—remember that interest rates are at historically low levels, and cash is paying virtually nothing. This isn’t the case in equities, nor in a few other spaces. I’m not suggesting increasing your risk posture without great consideration – instead, focus on objectively seeking value where it exists.
3. Don’t change your investment philosophy or strategy now—my experience has shown that successful investors hold tighter to their investment approach during times of uncertainty. Better to have an approach and philosophy that you believe in (even if it’s not perfect) than to not have one at all, because the damage caused can be material.
4. Be nimble—the world changes quickly, and the pace of change continues to increase. Make sure that your investment approach has the ability to make tactical shifts as new information emerges.
5. Favor quality and cash flow in this potentially low growth environment—going forward, as noted in previous posts about the “New Normal,” adjusting your return expectations downward and looking at cash flow as an important part of return will be critical. Don’t get seduced into reaching for yield or outsized returns.
How can you work through these types of world stress points? Be resilient. Be a survivor, and not a hero. Feel free to contact me if there is a specific question you would like me to address.