The unprecedented downgrade of U.S. debt by credit rating agency S&P on August 5 and subsequent steep decline in stock values are raising concerns about the strength of the U.S. recovery. The bad economic news, sources tell National Underwriter, may also lead to a rebalancing of investment portfolios as risk-averse clients seek safer havens for their retirement nest eggs.
Assessing the Impact
"The so-called S&P downgrade is a non-event," says Raymond Benton, a financial planner and principal of Benton & Company, Denver. "Of greater importance is the prospect of a global economic slowdown. And that [contraction] is more than likely what the market is currently discounting."
Patrick Collins, a financial planner and principal of Greenspring Wealth Management, Townson, Md., concurs, adding that investors and the public should not expect a 2008-like reprise of massive government intervention to boost economic activity because of Washington's focus on slashing the nation's spiraling red ink.
"The economy is having a hard time standing on its own two feet," says Collins. "If the federal government pulls out the crutches in the form of anti-growth legislation, that will be good long-term for attacking the nation's debt problem. But it could make it tough-going for investors in the short-term."
The economic uncertainty–many economists are now warning of a double-dip recession–could worsen an already long bear market. Mark Singer, a financial planner and principal of Safe Harbor Retirement Planning, Lynn, Mass., says the U.S. is now in the 11th year of a "secular bear market"–the 4th since 1900–wherein the prevailing trend of stocks is downward. If past secular bear markets are any guide, says Singer, the current one is likely to last for another three to five years.
Of more immediate concern to investors is the market's steep declines–initiated by the S&P downgrade, then fed by news about Europe's own debt crises–which could prompt advisors and clients to rethink long-held investment strategies for funding financial goals and objectives. One possible outcome, sources say, is a ratcheting down of investors' risk tolerance for exposure to equities and a flight to safer havens: bonds, certificates of deposit, money market funds and, yes, Treasuries.
Indeed, sources note, Treasuries have enjoyed an influx in capital since the S&P's action, an irony noted by market-watchers, as the agency's downgrade was the catalyst for the Dow Jones Industrial Average's 635-point drop on August 8 and cumulative dip of 1,147 points–9.13% of the Dow's value–over the next two trading days.
Some clients are making a hasty exit from the market on the belief that equities are due for a yet steeper plunge.
"I received a call from a woman who was so panic-stricken by the market drop that she insisted on moving all of her assets out of equities and into cash," says Lee Baker, a financial planner and principal of Apex Financial Services Inc., Tucker, Ga. "I've never experienced this before with a client. She just couldn't stomach losing any more money."
This reaction, however, seems to be the exception. Advisors say that most clients, though concerned about the market's volatility, are holding fast to recommended investment strategies. That's partly because the portfolios contain a mix of "uncorrelated" assets that don't all move in sync with the market's swings. Advisors say they've also cautioned clients to expect market slides; and to not act rashly following a big drop because the portfolios are custom-built to perform well over the long-term.
That may be, but Singer insists that investment decisions can no longer be guided by traditional asset allocation strategies: purchasing and holding particular classes of stock or debt instruments. Such a strategic approach must be supplemented by tactical investing that entails "minor and more frequent adjustments" to portfolios to insulate them against market fluctuations.
Benton agrees. "If they have not already done so," advisors should structure clients' portfolios to "reflect a thoughtful commitment to tactical, as opposed to directional, approaches, in recognition that we are in a secular bear market that started in 2000," he says.
Keys Tinney, a financial planner and principal at Littleton, Colo.-based Aveo Capital Partners, adds that tactical investing also entails holding client assets "locally"–buying and selling, for example, individual exchanged-traded funds or securities, as opposed to whole asset classes.
In years past this hands-on approach was inaccessible to individual advisors. But new software and a decline in custodian costs have enabled them to more proactively manage portfolios. Whatever the approach, Tinney cautions, investment decisions must be guided by factors that advisors can control.
"Many advisors mistakenly take credit for rises in the clients' portfolio values," says Tinney. "In reality, the one thing you can't control is market performance. What you can control is risk tolerance, expenses, taxes and liquidity. When you focus on controlling the controllables, then you can build a portfolio that minimizes the impact of market volatility while maximizing the return for a given amount of risk."
What might such a portfolio look like? Depending on the client's age, risk tolerance, and financial objectives, sources say, the portfolio should comprise a diverse mix of assets that tends not to fluctuate in tandem. Thus a precipitous decline in Dow Jones Industrial Average, as happened after the S&P downgrade, will be reflected in stocks and mutual funds that generally move in concert with the Dow. By contrast, fixed income securities–corporate bonds, money markets, CDs and Treasuries that make interest payments on a fixed schedule–tend to do perform well in bear markets.
A well diversified portfolio, experts say, will generally underperform the market when stock prices are rising, but outperform the market when equities are falling.
