October is a tough month for investments. History has not been kind to investors in this month of Tricks or Treats. And depending on how things play out in the halls of Congress over the next dozen hours, the world financial markets and US investor 401(k) accounts will find out if they’ve been given a nasty trick.
How Will Government Default Affect Your Money?
Remember seeing those guys walking around with signs “The End Is Near?” Well, from a financial point of view, those predictions are getting uncomfortably too close to reality.
If Congress can’t resolve it’s self-inflicted wound over the debt ceiling and government shutdown, then world markets may fall off a cliff. Maybe it won’t happen right away – though I tend to think it will be pretty fast in the bond markets – but it is certainly a risk that can happen. The dysfunction in government is reminiscent of a Banana Republic and threatens the reputation that we have as a global economic leader.
As things stand, the markets are up – way up – on hints of a deal being worked out. And up until now, the markets have basically been shrugging off the prospect of an actual default by the largest economy and reserve currency in the world. Each time a rumor spreads about a deal or a pending vote, the markets jump as investors anticipate putting this uncertainty behind them. And each time talks break down or a vote is postponed the market drops.
Capitol Gains at the Expense of Capital Gains
In Washington, it’s all about Capitol gains, not capital gains. There are those who are either economically illiterate or simply focused on political gains to understand – or better yet – believe that there will be any negative impact on business and household bottom lines when the ‘full faith and credit’ is downgraded.
The one thing that matters most to almost any business transaction is reputation. Are you a stand-up guy? Will you pay your bills on time? Can others rely on you to do what you say? This is the same at the household level as it is for business and more so for governments.
It used to be that your word was your bond. Now the world is a bit more complex and interconnected but a sovereign nation’s word is still important. And messing with that has huge consequences. Can you say ‘uncertainty,’ ‘recession,’ or ‘higher interest rates?’
Investor Play Book for Government Stalemate
How’s an individual investor to play this? By all other financial measures, the economy is OK and still growing, albeit slowly and not anywhere near as fast as needed to lower the unemployment rate. Corporate profits are high, earnings are up and companies are hiring. Under normal circumstances, this would be all that’s needed for an investor to make money in a stock.
But these are anything but normal times. And the shenanigans in Washington as petulant ‘adults’ play politics and risk global economic stability makes it VERY difficult to predict what’s going to happen, much less how to invest.
Hedge Your Portfolio
So, I’m like many of my peers: cautiously optimistic that the adults will actually show up and prevail. But this is precisely why we talk about the need to be more dynamic in asset allocations and not rely completely on Buy-and-Hold. Based on my reading of the tea leaves and signals available through services we use, we have raised cash levels and temporarily halted averaging into the market with any new money over the past couple of weeks.
This is also why I include a number of ETFs which focus on the value side of investing. Research has demonstrated that “low-volatility” strategies like those represented by value-oriented ETFs like USMV and SPLV can be good havens in times of stress and help hedge your portfolio.
Another way to play this would be to invest in Volatility ETFs and ETNs like VXX or XIV for short-term plays. While I can’t say that I hate Low Volatility ETFs like some analysts, I’m not using them in my MarketFlex portfolios any longer either for many of the same reasons outlined here by a Zack’s analyst. I’m not a fan of Exchange Traded Notes in general (too much reliance on the risk of the issuer). And unless you get in early, you end up at risk of losing when the volatility disappears.
Another option that may work are ‘managed futures‘ which follow strategies and assets that are supposed to be uncorrelated to the actions of the broad market. Over the past few years, more open-end mutual funds have become available making these accessible for low cost of entry for many investors.
But despite the claims of many investment managers who produce these various investments, I also recall that all of these ‘uncorrelated’ assets were suddenly very correlated when the whole world went to hell in a hand-basket at the beginning of the Great Recession and other Black Swan moments.
So, this is why the ultimate hedge in markets like this is simply: Cash is King. So while I still believe that most investors can’t successfully time the market – based on their experience, limited time and research resources – and you should continue to stay diversified, that doesn’t mean that you have to put everything at risk.
In my MarketFlex portfolios, we’re raising cash – even today – and taking about 20% out of the market as a way to put some “players” on the sidelines and keep them ready to jump in after this self-induced crisis period passes.
Heck, just because you can see the sun peeking through rain clouds doesn’t mean you shouldn’t wear a rain coat.