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Let’s get up to speed first

Last week, Congress & the White House came to a zero-hour agreement to raise the debt ceiling, covering the nation’s short term debt needs.  While there were some cuts made in future spending, the greater challenge of creating long term, meaningful solutions was left to a Congressional committee, charged with presenting a deficit reduction bill to Congress by Thanksgiving.

Friday evening Standard & Poor’s, an agency that rates the quality of various securities, debt obligations, governments and other entities reduced its rating of the U.S. government’s long term debt from its highest rating tier, AAA to the second highest rating tier, AA+.  There are varying opinions as to the validity of this decision, whether it was warranted or not and what it truly means for the economy, both in the U.S. and abroad over the long term.  Standard & Poor’s ultimately felt the current plan for reducing the debt is far from sufficient and that it needs to see more action from the government before improving their outlook.  As of this writing, the other ratings agencies have held the United States’ AAA status, but have warned that they, too, are concerned.

The world markets responded to these events in a very negative fashion on Monday, speeding up some already brisk downward moves from the week prior due to continued tension in Europe and slower than expected growth in various sectors here in the U.S.  Tuesday, the Fed released a statement confirming that interest rates will likely stay put for the foreseeable future.  Along with some positive corporate earnings, this news drove the market up nearly 4% and the Nasdaq up more than 5% on an extremely volatile trading day.

We continue to believe that the best defense in any market is to have a broadly diversified, low cost portfolio that is thoughtfully rebalanced to track with our client’s long term goals and tolerance for risk.  That said, we wanted to take this opportunity to provide our view on some commonly asked questions surrounding recent events.

Are my cash & short-term bond funds safe?

In a word, yes. The money market funds we utilize are of very high quality and will continue to provide safety and security for our clients’ cash reserves.  Much the same, the remainder of the fixed income side of the portfolios, while subject to market fluctuation, are all short term, high quality bond funds.  Using these tools helps protect our clients from a number of factors.  For example, the debt downgrade impacts long term U.S. debt, but its short term rating has remained unchanged, meaning the impact of the S&P downgrade is likely to be minimal.

What can we do?

For most of us, the option to pull out of the market is the worst possible scenario, as can be illustrated by the late afternoon rally on Tuesday.  We will take action by continuing to look for opportunities to buy low and sell high as the volatility provides rebalancing opportunities.  Sticking with our long term discipline served us very well in 2008 and 2009 as the purchases we made during the worst of times have produced the strongest returns since.

While this sometimes feels like a “do nothing” response, it isn’t.  The truth of the matter is, to quote author and financial planner, Carl Richards, “The time to prepare for a crisis is long before you find yourself in one.  It’s not a good idea to figure out how a parachute works after you jump out of the plane. Financial plans and asset allocation models are built for the long term. Large fluctuations in market value are expected and are necessary as the downswings provide the buying opportunities that we’ll take advantage of in future upswings.  How one responds to these temporary fluctuations over a lifetime of investing is what really tests us as investors.

This is the first time the U.S. debt rating has been downgraded.  Is this time different?

No. While the look and feel of this crisis has different characteristics of the prior crisis, which had a different look and feel than the one prior to that, these issues, while incredibly painful and emotional, tend to appear and behave like most financial crises in hindsight.  They are part of the natural economic cycle of booms and busts, the constant battle between fear & greed.
Corporations around the world continue to collectively be healthier than they’ve been in quite some time.  Many are sitting on larger than usual cash reserves and earnings have remained strong overall.  Famed economist Burton Malkiel recently said, “Panic selling of U.S. common stocks will prove to be a very inappropriate response…no one can tell you when the stock market will end its decline, but there are some things we do know.  Investors who have sold out their stocks at times when there have been very large declines in the market have invariably been wrong.”

Who should I be reading? What should I focus on?

The best answer is that you should be reading your favorite books and magazines, and focusing on that which you can control and enjoy.  If this current economic situation fits that bill, below are some excellent articles that help breakdown what has occurred of late and a variety of responses.

Resisting The Urge to Run Away – Ron Lieber, New York Times, August 5, 2011

Your Neglected Stock Market Backup Plan – Carl Richards, New York Times, August 8, 2011

Don’t Panic About the Stock Market – Burton Malkiel, The Wall Street Journal, August 8, 2011

This crisis will come and this crisis will go. The same goes for the upswings. When they will occur is something that no one can tell you with any degree of accuracy, certainty or consistency. It’s tough to feel positive in the midst of so much uncertainty, but take solace knowing that if you stick to your disciplined plan and stay focused on long term results, you’re prepared.

Chip Workman, CFP®