Investing amid the Uncertainty in Washington

Perhaps the most asked question by investors these days is: How do I adjust my portfolio for the new administration in Washington?

We’re in a period of what I think is unusual uncertainty in the markets. Before considering any potential change in policies, uncertainty already was very high.

As you know, we’re still dealing with the change in the long-term credit and debt cycle. Debt increased steadily from about the end of World War II until 2007. Debt growth helped increase economic growth above what it would have been.

In 2007, however, we reached a point where the debt levels were unsustainable. That led to the financial crisis. We’re still in a transition period in which debt is slowly retreating to levels that are sustainable over the long-term. The debt reduction causes lower levels of economic growth. This transition period is when we’re also at risk of policy mistakes causing deflation and negative economic growth.

At the same time, we have the regular three- to seven-year business cycle. In the United States, we’re in the positive phase of that cycle. We have sustainable growth. Inflation and wages are starting to rise. Stock valuations are at high levels. The Fed is tightening monetary policy.

So, we have those two cycles in tension.

That was the situation on Election Day and it remains the situation today.

Now, we add the potential for policy changes, and that increases uncertainty.

After the election, investors focused on the positive potential policies: reduced regulation, tax reform and pro-growth policies.

Since the inauguration, other possibilities have grabbed investor attention: trade and immigration restrictions, conflicts with other countries and the difficulty of pushing some of the Trump administration’s proposed policies through Congress.

These conflicts and the related uncertainty are why many investors are wondering how they should change their portfolios. What’s particularly unusual as I look across global markets is that market pricing doesn’t reflect the high level of uncertainty and wide range of outcomes that are possible. Investors don’t seem to have adapted their portfolios to their thinking and concerns.

I continue to advise that you not try to anticipate a particular set of policies or outcomes. Yes, you could be correct and have a high return. But there’s a greater probability you’ll be wrong and suffer a major loss. The number one rule of investing is to avoid large losses.

In this period of high uncertainty, you want a high level of diversification. You won’t earn the highest return in any extreme scenario. But you take almost all the probability of a large overall loss off of the table. Whatever happens, some of your investments will benefit while others won’t. You should earn steady, solid returns, as we’ve done for years.

I also recommend having a process that helps you determine which changes to make. That’s what we do at Retirement Watch. We look at the factors that matter to the markets and let those tell us how to modify our portfolios as markets and the economy change. We don’t chase headlines, short-term market changes and forecasts.

It’s also important to focus on liquid assets and markets. In times of crisis, liquidity tends to be reduced. Investments with low trading volume and liquidity tend to drop sharply in price and have no markets at all for a while, as happened in 2008.

Those are the three principles you need in this time of high uncertainty.

The Data

As we expected, last week’s Employment Situation reports were very positive. More jobs were created than most forecasts anticipated. On the downside, hourly wages barely increased, and hours worked stayed the same. The growth in wages and hours that we saw through much of 2016 slowed in the last few months.

The JOLTS (Job Opening and Labor Turnover Survey) also was mostly positive. Job openings increased. Hirings also increased. That’s a positive change from the recent past when employers said they couldn’t find the type of workers they wanted, so there’s been a gap between openings and hirings for a couple of years.

The non-manufacturing sector of the economy continues to do well. The ISM Non-Manufacturing Index essentially held steady at a high level, plus several components of the index were very strong. The PMI Services Index also reported an increase to 55.6 from 53.9 from December.

Factory Orders had a 1.3% increase in the headline number. The key component is core capital goods. This marked the third straight month of solid increases, and showed business investment finally is climbing after years of stagnation.

Consumer Credit increased but at a lower rate than in recent months. Auto and student loans continue to increase, but credit card use didn’t grow as much as in previous months. This is consistent with the low growth in retail sales in December.

The Markets

The S&P 500 gained 0.71% for the week ended with Wednesday’s close. The Dow Jones Industrial Average rose 0.95% and is back above 20,000. The Russell 2000 returned only 0.01%. The All-Country World Index rose 0.51%. Emerging market stocks returned 0.35%.

Long-term treasury bonds soared 2.64%. Investment-grade bonds gained 0.98%. Treasury Inflation-Protected Securities (TIPS) appreciated 0.34%. High-yield bonds rose 0.08%.

The dollar rose 0.58%.

Energy-based commodities dropped 1.15%. Broad-based commodities lost 1.2%. Gold appreciated 2.58%.

Bob’s News & Updates

For those who can’t attend the MoneyShow Orlando this week, one of my presentations will be streamed live on the web free. Click here for details.

If you’re retired are thinking about retiring, you should read my latest book, the revised edition of “The New Rules of Retirement.”