Your Crisis Protection Package
It’s not the one you see that nails you; it’s the one you don’t see. That bit of country wisdom applies just as aptly to major market events as it does to passing an oversized truck on a two-lane road.
The “one” we’re seeing now is, of course, the much feared “fiscal cliff,” the package of $500 billion in spending cuts and tax increases that will kick in January 1 if Congress and the president do nothing. And from the rancorous nature of the debate now unfolding in Washington, it appears that the fiscal dealmaking will be a cliffhanger indeed.
Speaking today at a toy factory in Pennsylvania, President Obama warned of “prolonged negotiations” with Republicans on the budget and taxes. House Speaker John Boehner, meanwhile, pronounced current talks a stalemate at his news conference. Partisans on both sides seem willing to don blindfolds, join hands and leap off the cliff if they don’t get their way.
Congress also faces a challenge to raise the federal debt ceiling by the end of the year, to avoid an unprecedented US government default. Fortunately, there seems to be more progress on that front, with a bill likely to be submitted for a vote next week. But here, too, there’s no certainty about the outcome.
The consequence of Washington’s failure on either count is a likely dip into recession. And as many European countries have discovered, the resulting drop in government revenue from slower growth could actually wind up worsening the US federal deficit, even with higher tax rates and reduced spending. In fact, several countries are actually caught in an austerity trap, with contractionary fiscal policy driving up unemployment and deepening the recession.
However, the good thing about being able to see a crisis coming is being able to prepare for it. And there are already some clear signs that US businesses and households are geared up to handle the worst case. Despite an upward revision this week in US third-quarter gross domestic product (GDP) growth to 2.7 percent, many are hunkering down by cutting back investment.
For the past three plus years, US corporations have used record low corporate borrowing rates not to leverage up for expansion, but to de-leverage balance sheets. The primary reason is fear of another recession and a potential reprise of the 2008 credit crunch. Households have done much the same thing, slashing debt despite its lower cost.
As I’ve written before in this publication, my view is politicians will eventually reach a compromise to avoid the worst effects of a fiscal cliff. After all, they can see it coming too, and particularly the wrath of voters if they’re seen to be fiddling while America is burning.
A recession, for example, would throw cold water on anything the Obama administration hopes to accomplish even before its second term gets underway. And digging in their heels on tax rates won’t get the Republicans anywhere either, because refusing to compromise will simply return levies to Clinton era levels.
The fact that so many individuals and companies are preparing for the worst now is also a very good sign. With so many hunkered down, there’s only so much damage a real fiscal cliff could do.
To be sure, there will be casualties. But this is precisely the opposite of where investors, corporations and individuals were in early 2008, prior to that systemic crisis. The only way anything can morph into such a calamity is if enough people are leaning in the wrong direction.
Put another way, the evaporation of Lehman Brothers was truly the one the market didn’t see coming. So was the bankruptcy of Enron in 2001, which occurred when the company’s credit rating from Standard and Poor’s was still BBB+. Every major crisis since the Great Depression has only been possible because investors, corporations, individuals and governments least expected it, and were therefore least prepared for it.
That doesn’t make a crash this time any more palatable. And as we’ve been advising in Personal Finance and throughout the Investing Daily family, there’s no excuse for not crash-proofing your portfolio now before the possible storm hits.
That means the following:
The good news is all of these measures are pretty much what investors should be doing even if there’s no fiscal cliff. Protecting yourself is really the same thing as gearing up to profit if indeed reason does prevail in the nation’s capital.
Focusing on quality companies in a diversified portfolio is the best way to prepare for the proverbial one we don’t see yet—the crisis that will inevitably knock the market on its ear when the current turmoil is well in the rear view mirror.
The “one” we’re seeing now is, of course, the much feared “fiscal cliff,” the package of $500 billion in spending cuts and tax increases that will kick in January 1 if Congress and the president do nothing. And from the rancorous nature of the debate now unfolding in Washington, it appears that the fiscal dealmaking will be a cliffhanger indeed.
Speaking today at a toy factory in Pennsylvania, President Obama warned of “prolonged negotiations” with Republicans on the budget and taxes. House Speaker John Boehner, meanwhile, pronounced current talks a stalemate at his news conference. Partisans on both sides seem willing to don blindfolds, join hands and leap off the cliff if they don’t get their way.
Congress also faces a challenge to raise the federal debt ceiling by the end of the year, to avoid an unprecedented US government default. Fortunately, there seems to be more progress on that front, with a bill likely to be submitted for a vote next week. But here, too, there’s no certainty about the outcome.
The consequence of Washington’s failure on either count is a likely dip into recession. And as many European countries have discovered, the resulting drop in government revenue from slower growth could actually wind up worsening the US federal deficit, even with higher tax rates and reduced spending. In fact, several countries are actually caught in an austerity trap, with contractionary fiscal policy driving up unemployment and deepening the recession.
However, the good thing about being able to see a crisis coming is being able to prepare for it. And there are already some clear signs that US businesses and households are geared up to handle the worst case. Despite an upward revision this week in US third-quarter gross domestic product (GDP) growth to 2.7 percent, many are hunkering down by cutting back investment.
For the past three plus years, US corporations have used record low corporate borrowing rates not to leverage up for expansion, but to de-leverage balance sheets. The primary reason is fear of another recession and a potential reprise of the 2008 credit crunch. Households have done much the same thing, slashing debt despite its lower cost.
As I’ve written before in this publication, my view is politicians will eventually reach a compromise to avoid the worst effects of a fiscal cliff. After all, they can see it coming too, and particularly the wrath of voters if they’re seen to be fiddling while America is burning.
A recession, for example, would throw cold water on anything the Obama administration hopes to accomplish even before its second term gets underway. And digging in their heels on tax rates won’t get the Republicans anywhere either, because refusing to compromise will simply return levies to Clinton era levels.
The fact that so many individuals and companies are preparing for the worst now is also a very good sign. With so many hunkered down, there’s only so much damage a real fiscal cliff could do.
To be sure, there will be casualties. But this is precisely the opposite of where investors, corporations and individuals were in early 2008, prior to that systemic crisis. The only way anything can morph into such a calamity is if enough people are leaning in the wrong direction.
Put another way, the evaporation of Lehman Brothers was truly the one the market didn’t see coming. So was the bankruptcy of Enron in 2001, which occurred when the company’s credit rating from Standard and Poor’s was still BBB+. Every major crisis since the Great Depression has only been possible because investors, corporations, individuals and governments least expected it, and were therefore least prepared for it.
That doesn’t make a crash this time any more palatable. And as we’ve been advising in Personal Finance and throughout the Investing Daily family, there’s no excuse for not crash-proofing your portfolio now before the possible storm hits.
That means the following:
- Stick with stocks, whatever their sector, with histories of weathering previous crises as businesses. There’s no better proving ground than 2008.
- Avoid companies with large amounts of debt coming due in the next 12 months. Having to refinance during what proves to be even a temporary credit crunch can be disastrous.
- Keep some cash on hand to pick up bargains if there is a selloff.
- If you own dividend-paying stocks, make sure yields are funded with reliable revenue. Again, companies that were able to maintain or increase dividends during 2008 are pretty good candidates.
- Stay diversified among individual companies as well as sectors. Overloading may work out but it can also be a prescription for disaster in uncertain times like these.
- Keep some money in stocks that pay dividends in other currencies besides the US dollar.
- Resolve to hold onto good companies as long as their underlying businesses stay healthy. Even the strongest stocks took hits in 2008 but they soon recovered when overall conditions improved. If the businesses are still in good shape, the worst possible action is to sell their stocks after they’ve dropped.
The good news is all of these measures are pretty much what investors should be doing even if there’s no fiscal cliff. Protecting yourself is really the same thing as gearing up to profit if indeed reason does prevail in the nation’s capital.
Focusing on quality companies in a diversified portfolio is the best way to prepare for the proverbial one we don’t see yet—the crisis that will inevitably knock the market on its ear when the current turmoil is well in the rear view mirror.