CINCINNATI BUSINESS COURIER
September 3-9,1990
Investments
By Charles D. Vaughan
Investor inaction costly amid crisis in Mideast
GET TOUGH.
There’s an old saw that says, “When the going gets tough, the tough get going.” This is a trite but true expression. At no time in the past decade has it been more apropos than now.
The Mideast crisis has challenged America and other freedom loving nations to action. Doing nothing is not a viable option. The reverberations throughout the world financial markets have issued a similar challenge to investors. Inaction could be costly.
What’s changed? Since Iraq moved against Kuwait there have been at least three major long term changes in the financial markets. If, by some miracle, a peaceful resolution were achieved tomorrow, these would remain.
The sky has fallen. There are now thousands of Chicken Littles with press cards running around spreading panic. Any longtime market observer can tell you that the news follows (and justifies) the action. With stock and bond markets both dropping, there is now a plethora of negative “news” to explain why. Repetition builds belief. Market psychology shifts from “make me more money” to “get me even and get me out.”
The Emperor has been seen naked. For the past several years, we have been pounding our national chest about having defeated the business cycle. Recessions are a thing of the past, right? Now we are faced with the gutwrenching truth that it was mostly illusory. The price of staying the course has been a massive buildup of debt at all levels: federal, state, local, corporate and personal.
Now, in the midst of righting a massive budget deficit and an omnivorous savings and loan bailout, we are forced into an expensive conflict. Debt is an issue that can’t be ignored any longer. Risk is real. There is an unmistakable flight to quality.
Pandora’s box has been opened. The United States, and much of the Western world, has kept the lid on inflation despite positive economic growth and rising debt. Many other parts of the world have experienced hyperinflation accompanied by a weak economy. Deft mental partitioning has allowed us to maintain the attitude that our results came from superior monetary management.
The spontaneous combustion that blew oil prices skyhigh overnight woke us up. Energy prices are unlikely to recede to precrisis levels. These higher costs will soon be a good excuse for others to follow suit. It should now be obvious to any who cares to look that economics cannot be controlled by a small group of people meeting periodically to nudge interest rates to and fro. Inflation is contagious and we are not immune.
We have been spoiled by relatively well behaved financial markets for the past several years. Now they have begun to act up. Most investors have seen their portfolio values drop sharply. Inflation has reappeared and motivation has shifted from greed to fear. The going has gotten tough. What can you do about it?
The first step is to review your defense. There are two ways to reduce risk balance and diversification. Balance also is called asset allocation. This means spreading your investment funds across several different classes of assets that have different economic characteristics. By maintaining set ratios of investments in each class, it is possible to hedge against inflation, recession and economic upheaval at the same time.
Because of market action in recent years, most investors have little protection against inflation. Serious consideration should be given to establishing an allocation for real estate, energy and tangible investments.
Diversification means not putting all your eggs in one basket. This relates to spreading funds among different investments within the asset classes. No matter how careful we are in selecting, some investments will always do better than others. This protects us from having everything in the underperformers.
The second step in your review is your offense. Once you have a sound strategy defining your asset allocations and establishing your diversification method, you can look for the best profit potential. Frequently after a drastic drop in market prices, true values emerge. This is a great time to upgrade your portfolio.
The first consideration should be risk reduction. With a new emphasis on quality, any investment that appears vulnerable to a slow economy or rising interest rates is suspect. This includes many leveraged buyouts. On the other hand, closed end mutual funds may fall to deep discounts in a bad market actually offering less risk and more return.
The important point is that tough times will crush the overextended and poorly managed enterprises. The well financed and managed will survive and prosper.
Damon Runyan said that the race is not always to the swift nor the battle to the strong, but that’s the way to bet.