What I do Worry About

As I write this entry at the close of the market on Tuesday, November 18th, the market finally was able to sustain a gain without the afternoon selloff and continues bumping along in a volatile fashion. Unfortunately, I expect the volatility to continue at least into early next year. Stocks are faced with low confidence, poor visibility on earnings and a significant amount of tax selling (which will continue into December). This is balanced by pretty attractive valuations in a lot of areas, large institutions rebalancing their portfolios (from fixed income to stocks, in general) and (we hope) a winding down of forced selling by hedge funds and other leveraged entities.

As I have written before, I always liked client meetings because they often force you to look at problems in a different light and question your thinking. I had a client ask recently if there was anything that would change my mind about staying the course on a well thought out and diversified asset allocation for the long haul. I came up with six conditions that, in the current environment (or any environment for that matter) would concern me to the point that I would have to reconsider our involvement with some or all of the assets classes that we invest in. These would be:

1. If the Fed withdrew liquidity from the system by shrinking the money supply. Note that thus far the Fed and all other G7 central banks have been exceptionally accommodative in this respect. The Central banks must act as a counterweight to what is going on in the economy. Deflation must be countered with an increase in the money supply and vice versa in an excessively inflationary environment.

2. Attempts to restrict foreign trade. The imposition of tariffs or any barriers to trade globally would be a very bad sign. Note also that currently trade between most of the free world remains relatively unrestricted.

3. A refusal to provide fiscal stimulus on the part of G7 governments. In the present situation it is vitally important that government spend money to counteract the slowdown in the private sector.

4. Any attempts at wage or price fixing. One of the things that prolonged both the Great Depression and the stagflation of the 1970’s were the government’s ill-fated attempts at establishing legislated price and wage levels.

5. A large increase in taxes. This includes imposing excise taxes on the sale of goods and services. I accept that taxes will probably go back up to where they were during the Clinton Administration. I would prefer no tax increases until we are clear of the current mess. But moderate increases are not an economy killer. One of the New Deal’s errors was tripling taxes during the mid 1930’s.

6. Increases in the cost of employing people. Whether its increased payroll taxes or increased regulation, compulsory unionism or whatever. We must not discourage employers from hiring.