The other shoe has dropped!
We have been advising caution for some time as the global economic situation has continued to deteriorate. Despite all the election rhetoric, the U.S. economy has shown virtually no improvement this year. Now we are seeing that, in spite of trillions in stimulus from the federal government and the Federal Reserve, we are actually sinking again.
The unemployment rate is edging back up and reported corporate earnings have been very weak. Now all the talk is about the “Fiscal Cliff”, which will automatically require federal tax increases and spending cuts of nearly $800 billion, a hit of about 5% to the total economy (GDP) beginning January 1, 2013. It is highly unlikely that even our contentious Congress will allow all of this to take place. However, parts of it are already assured and the uncertainty alone is taking its toll on the economy by causing decision makers to delay any action until the issues are resolved, probably near yearend.
Along with renewed concern over problems in the Euro zone and saber rattling in the Mideast, investors have a lot to worry about. None of these issues is going to go away any time soon. Meanwhile the economy is tottering on the edge of a recession. If any significant part of these automatic negatives is allowed, a recession is likely next year. Stock prices are still up around 2% (based on the S&P 500 Index) are just now beginning to reflect some of these concerns.
For the past year stock trading volume has been very light compared to historic averages. In addition 50% or more of that reduced volume has been due to High Frequency Traders, who do not hold overnight positions. This adds up to a very dangerous condition. Any negative surprise that sets off a panic could take stock prices dramatically lower as happened on May 6, 2010 when the Dow Jones Industrial Average dropped 900 points in less than 20 minutes.
We believe it is now time to “winter proof” your portfolio. We are not predicting calamity, just issuing a “storm warning”. The conditions are right for a panic that could seriously impair portfolios. Keith Bookbinder, Gary Williams and I are actively running Portfolio Stress Tests to get an idea of how we might hedge against the potential macro risks. Of course there is no certainty that they will be effective or even needed. But, we believe it is better to try to preserve equity than to attempt to get it back. We will be making recommendations very soon to clients as appropriate.