Five Things to Keep In Mind During the U.S. Debt

Crisis 

Time is growing short and patience is wearing thin for investors as they contemplate the stalemate in Washington over raising the debt ceiling. As uncertainty over the standoff between Democrats and Republicans has intensified, the volatility in the stock market has ratcheted up accordingly. Many investors are growing increasingly fearful about the potential of a downgrade in the rating of U.S. government debt or, worse, the impact of an outright default.

 

No doubt about it - the debt crisis is just that: a "crisis". The stakes are extremely high. The outcome is uncertain. The impacts are potentially huge. Those are the undeniable hallmarks of a crisis.

 

Investor psychology being what it is, we all struggle with the uncertainties of every new crisis that comes along. Each one has its unique aspects, which makes it easy for us to "what if" the multiple scenarios to their worst-case conclusions.

 

The reality is that every crisis is unprecedented; that, after all, is what makes them crises. It was unprecedented when terrorists slammed planes into the World Trade Center in 2001. It was unprecedented when the Arab nations cut off our oil supply in 1974. It was unprecedented when Japan bombed Pearl Harbor in 1941. It was unprecedented when the South ceded from the Union in 1861. Such is the nature of historical events.

 

The question for long-term investors is - what to do?

 

Here are five points to consider in the days ahead as the debt crisis reaches a conclusion - whatever that conclusion may be:

  1. Our government is finally being forced to deal with its spending addiction: The scene in Washington has been ugly, but the subject matter is one that is long overdue - how to tackle our ever-growing government debt problem. For the first time perhaps in our history, both political parties agree that the budget deficits we are running are unsustainable. How to remedy that problem is, or course, where all the contention is. Many investors had convinced themselves that our country would never grapple with the realities of our government's addiction to deficit spending, but the market - led by the ratings agencies - is forcing our government's hand. While it may be painful, the fact that our elected officials are being forced to confront these issues is, in our opinion, a welcome change.
     
  2. Focus on your plan, not the macroeconomic environment: Whatever path the debt ceiling crisis ultimately takes, history shows that, in the long run, such events are blips on the historical timeline. Thirty-five years ago, in 1976, investors obsessed over runaway inflation and a dysfunctional economy. "Malaise" was the term of the day. The Dow seemed stuck in a trading range of 800-1000 and many pundits proclaimed it to be the "death of equities." Today, despite all the financial shocks in the intervening 35 years, the Dow stands north of 12,000. And can you think of a single thing that investors were worrying about in 1976 that still matters today?

    Now consider that a 55-year-old today has a life-expectancy of 35 years. For most people, those years will be spent in retirement, living on their nestegg. Focus, therefore, on your plan for sustaining that nestegg through what will likely be a long retirement, and don't let the "crisis du jour" knock you off track.
     
  3. Ask yourself the question: "Then what?": Many investors are anxious about the thought of experiencing another bear market. The prevailing thought is often, "What if the market drops, say, 30%? I don't want to experience that scary feeling again." 

    There is a question investors should ask themselves when they find themselves fearing a market downturn. The question is this: Then what? In other words, when the market does indeed drop 30% at some future point - then what? Does the market stay down 30% forever, proceeding forward on a flat line into eternity? Is the decline a permanently lower plateau from which we will never recover, despite the fact that stocks have recovered from every other crisis we've ever faced?

    That, of course, is not the way the stock market works. 
    Stock declines are inevitable, and their underlying cause is less important than the fact that they are a normal part of the market cycle. Historically, declines of 20% to 30% occur about every three to five years. Keep in mind, however, that this is a long-term average; these declines sometimes occur several times in succession, and sometimes occur only once a decade. And, as we have seen in the past two years, stocks typically enjoy a rapid recovery once the downturn has run its course.
     
  4. Economies are resilient: As we noted, the U.S. economy has experienced a lot of shocks to its system going back to the 1970s, and yet U.S. stocks have generated healthy long-term returns during that time frame. Even in the most extreme times, economies often exhibit surprising resilience. Germany and Japan were totally destroyed by the events of World War II - physically and economically - and yet within 15 years they were emerging as two of the world's most vibrant economies. By the 1980s they were the world's second and third largest economies, respectively. Even today, recent headlines have abounded with the news that Japan is recovering from its devastating earthquake much more quickly than experts expected.

    Economies are resilient because people are resilient. It is a reality that the doom-and-gloomers always underestimate, and it is why they are constantly surprised that things didn't turn out as badly as they expected.
     
  5. The media wants you to worry: Remember, the media's job is not to impart sound investment advice. The media's job is to attract and hold eyeballs. The electronic and print media makes its money by drawing you into their show or article and then trying to keep you hanging around for as long as possible. They accomplish this by playing on your emotions, and fear is our most powerful emotion. There is nothing wrong with staying informed, but recognize that the media today is engaged in a never-ending effort to find the worst-case scenarios out there and convince you to worry about them. The more time you spend immersing yourself in worst-case scenarios, the harder it will be to maintain a long-term outlook. 

 

Many people today seem to have the mindset that investing in the stock market is a sort of roulette game. Up today, down tomorrow - it's all about luck, they seem to believe. But the reality is that stock returns are driven by the cost of capital for corporations. Companies go to market to seek capital by offering shares of their company stock to the public. Investors, in exchange, demand a return on that capital.

While events such as the financial crisis of 2008-09 may cause dislocations in this reality, it always reasserts itself over time. Investing in "stocks" is about investing in "companies" and companies, as a group, are not as vulnerable to the whims of short-term events as it often seems.


Something to keep in mind in the days ahead.