“Debt, Default, and the Risk of Disaster”
By R.Kevin O'Keefe, CIMA®, AIF®
We are all aware of the basics of the situation. Recent months have seen mounting tensions in American politics. In May, the Federal government ran up against our national “debt ceiling,” making it all but impossible to continue paying all of our nation’s bills. Treasury Secretary Geithner managed to rearrange some of the payments, pushing the day of reckoning off until August 2, 2011.
Raising the debt ceiling has, in the past, been a noncontroversial step—but this time Congressional Republicans seized the opportunity to link it to plans to bring the Federal budget much closer to balance in the long run. This has led to deadlock, with the leaders of both parties having tremendous trouble bridging the gap between their positions on the proper balance between spending cuts and tax increases. (See CNN’s “Cheat Sheet” for a handy summary: http://www.cnn.com/2011/POLITICS/07/15/debt.talks.cheat.sheet/index.html.) We are now about one week from the end of this story—one way or another.
But how it will turn out, and what that might mean for the economy—both the American economy and the world economy—are still unclear. Will our politicians manage to put together a deal before the deadline? If they do, what sort of a deal will it be? And, either way, what will happen to the economy, and the markets? The press is full of people who are willing to make predictions, and the scenarios they are spinning range from catastrophe to a major “relief rally.”
First Affirmative’s Investment Committee has been monitoring the situation closely, of course. It is impossible to say how the serious political problems will be resolved, or what that resolution could mean to the global economy and the financial markets.
At the moment, the markets are relatively stable and appear to reflect a consensus expectation that Congress will come to terms on a deal in time to prevent a default.
It is important to keep in mind that investment decisions are entirely about process, and not about outcomes, precisely because outcomes are uncertain and can only be known after the fact. Outcomes matter, of course. But the best way to achieve desired investment outcomes is by following a disciplined investment process, and such a process must be designed around the fact that uncertainty is ever-present, even when it may appear otherwise.
To put it another way: if we believe we have a good investment process, we must follow that, even when it is hard to do so. To achieve investment success, it is important to believe our beliefs and doubt our doubts.
No one knows what the outcome of this crisis will be, or how the financial markets will behave. What we do know is that historically, periods of heightened anxiety—which would have worried many investors to the point of selling risky assets and taking cover in safe assets—usually turned out relatively well, much to the detriment of those investors who bailed out.
To our investment clients: We recommend that you consult with your investment advisor and discuss the investment policy you currently have in place—and call or write your elected representatives, to let them know what you think.
Posted: July 26, 2011