By JEFF SOMMER – NYT
The stock market began the week in a funk and ended in subdued celebration as apparent progress in the debt-ceiling impasse seemed to confirm the Wall Street consensus that dysfunction in Washington won’t lead to a debt default or set off a global cataclysm.
Buy-and-hold investment strategists say it’s likely — though by no means guaranteed — that long-term investors who stick to a well-thought-out plan can ride out awkward periods like this with few ill effects.
In retrospect, that approach worked well for people with the fortitude to embrace it through the financial crisis in 2008, said Joseph H. Davis, Vanguard’s chief economist. And market downturns, he said, are typically resolved with much less damage.
“Looking back years from now, it’s likely that investors won’t even be able to pinpoint this period on a long-term stock chart,” he said.
But he added an important caveat: there is, of course, no certainty that all details of the conflict in Washington will have a peaceful and prosperous outcome. That creates a problem for investors, one for which there is no entirely satisfactory answer.
Despite compromise proposals to raise the federal debt ceiling temporarily, it remains possible that the debates in Congress and at the White House over financing the federal budget, and, more critically, raising the statutory borrowing limit for an extended period, will not be resolved smoothly. The government did partly shut down, after all, consigning thousands of workers to furloughs, closing government services and institutions and delaying pay for government contractors.
The fact that the markets have been taking the threat of a debt default in stride could, perversely, allow politicians to behave with nonchalance, in the belief that there is no grave problem for financial markets, said Liz Ann Sonders, chief investment strategist at Charles Schwab & Company.
“It may be that the politicians want the market to riot, as a way of giving them cover for making a deal, but the markets have been thumbing their nose at Washington, and acting with, maybe ‘educated complacency,’ because we’ve been through this so many times before.”
And when the next deadline arrives, they could conceivably allow the debt ceiling to be breached, with consequences that are uncertain yet profoundly unappealing, in the eyes of most financial strategists. “We’d be in unknown territory then,” said Richard Madigan, the chief investment officer of J.P. Morgan Private Bank. “The entire global financial system is based, to a large extent, on the United States dollar and the United States Treasury bond.”
Dirk Hofschire, senior vice president for asset allocation research at Fidelity Investments, put it this way: “Treasuries are critical, not only from the theoretical valuation standpoint — all other assets are valued in relation to Treasuries — but also from a more basic standpoint. Look at the global financial system as a kind of plumbing. Treasury bills and bonds are one of the key components of all that plumbing.”
Tampering with the creditworthiness of Treasuries is almost unthinkable, several strategists said, yet the markets have been forced to contemplate it.
“We’ve been telling our clients that there’s a 90 percent probability that there won’t be a default,” Mr. Madigan said on Wednesday. “The problem is, that 10 percent probability shouldn’t be there at all, and it is.”
Early last week, yields rose sharply on short-term Treasury bills that come due on Thursday — when the Treasury originally said the government would exhaust the “extraordinary measures” it has been taking to pay its bills. Prudent money managers have been trying to prepare for possible problems in the debt-ceiling negotiations.
Fidelity, for instance, said in a statement that its money market funds did not now hold “any securities issued by the U.S. Treasury that mature in late October.”
As reports of a possible breakthrough in the debt talks spread through the market on Thursday, yields on those very short-term Treasury bills began to fall — but those on T-bills that mature around Nov. 22, the deadline that was proposed by House Republicans, began to rise.
Steven C. Huber, a portfolio manager at T. Rowe Price, said that in past bouts of market uncertainty, Treasury notes and bonds had been seen as havens. While that’s still likely to be true — because a debt default is unlikely, in his view — he said that continuing tremors in Washington could eventually result in rising values for other sovereign bonds, those of Germany and Canada, for example, to the detriment of Treasuries. “Political risk like this is very difficult to handicap,” he said. “It’s not like economic risk, which is hard enough but which can be analyzed. The problem here is that we really don’t know what’s going to happen.”
That’s why most mainstream analysts recommend that if you can afford to do so, it’s probably wise to stick with a long-term asset allocation strategy. Scott Clemons, chief investment strategist in the wealth management unit of Brown Brothers Harriman, the nation’s oldest private bank, said, “We have always tried to take a long-term view based on our analysis of price and value, and that’s what we’re doing now.”
Corporate profits will be critical to future stock price increases, he said. “Earnings season is just beginning, and it’s what we’re looking at most closely,” he said, with the caveat that a prolonged impasse in Washington — and, particularly, a collision with the debt ceiling — would have hurt the economy as well as earnings.
The consensus of most strategists is that — barring a disaster — stocks will continue to be in a bull market cycle. One reason is that monetary policy is expected to remain accommodative for some time. The nomination last week of Janet L. Yellen as Ben S. Bernanke’s successor at the Federal Reserve and the stresses imposed by the fiscal debate imply that the Fed will continue its current policies for a while longer. And the consensus view is that the economy, globally and in the United States, is expected to continue to grow modestly — again, with the caveat that a severe shock could render all predictions invalid.
If the probability of a disaster in Washington is low, it doesn’t make sense to liquidate long-term investments in order to protect oneself against it, many strategists said. “One problem with taking your money out of the market is that you don’t know when to put it back in,” said Mr. Madigan of J. P. Morgan. Reducing stock investments modestly might make sense as a tactical move, Ms. Sonders of Schwab said, if you believe the market is vulnerable now and is likely to rise. “If you did that, you’d want to be planning on putting it back in — and, of course, knowing how to time that right is very, very difficult.”
Of course, investing for the long-term is a luxury that many people can’t afford. “The furloughs, the people whose businesses are being negatively affected, those cash flow interruptions are a reminder that people need an emergency fund, amounting to roughly 15 to 30 percent of their annual income,” said Stuart Ritter, a senior financial planner with T. Rowe Price. “That helps you get through a crisis, if it arrives, whatever that crisis might be.”
Beyond that, he advised not spending too much time analyzing events that are unknowable, like the outcome of the debt negotiations in Washington. Instead, he said, focus on events that you know will come, like a child attending college or your own eventual retirement. “Make a long-term plan for saving and investing for these things,” he said, “and don’t worry too much about the rest of it.”
AND if you are able to invest, Mr. Davis of Vanguard says it is important to prepare for moments that won’t be easy. “There are always crises and there always will be, unfortunately. So if individual investors find they’re really uncomfortable going through this one, it may be a sign that they’ve got too much risk in their portfolios, and maybe they need to rethink their long-term plan, and remove some of that risk.”
Unless they accept some risk, he said, investors will have to accept very low returns on their investments. “It’s a trade-off, unfortunately,” he said. “It’s one that you as an individual need to make at your own comfort level.”
And once you’ve found that level, he said, it’s usually best to invest for the long run, regardless of the day’s events in Washington.