Investor risks of action/inaction
By Kyle Tetting
Despite an incessant focus on the debt ceiling conversation and what appeared to be a surprisingly optimistic response by markets in recent weeks, actual progress on the matter has been slow. As I write this, there remains some time before the likely June 1 deadline. But, as with most market-related observations, by the time you read it, much of it could be dated. As a result, our current dependence on politicians has investors aiming their portfolio away from some risk that we aren’t even sure is out there.
For their part, traders, attempting to read the tea leaves, seem to be shifting sides by the day. Through much of mid-May, the bet seemed to be on a deal being reached well ahead of any risk to government payments. But, as negotiation after negotiation failed to yield meaningful news of a compromise, moods soured. Not only is shifting sentiment expected in the face of uncertainty, a mixed and changing response isn’t unique to traders.
Minutes from the Federal Reserve Board’s early May meeting showed a policymaking body that also had some mixed emotions on its next steps. A few participants noted in comments that they did not expect it was necessary to further firm policy. Others noted that progress toward a 2% inflation target may continue “unacceptably slow” if not for further tightening. Economists tend toward broad ranges in making forecasts, but the current environment feels increasingly uncertain. While unnerving, such broad ranges of expectations are borne out by the very environment we continue to find ourselves in.
Federal Debt Limit Myths vs. Facts, from the Bipartisan Policy Center
Despite a broad expectation that economic growth will continue to slow and amid clear signs that certain areas of the economy already have, the labor market remains strong. With consumer spending accounting for more than two-thirds of gross domestic product, economic catastrophe seems unlikely as the unemployment rate sits at just 3.4%. Those looking for work have options, so a massive slowdown in spending seems less likely.
All of this is to say that there are meaningful risks to both action and inaction. Assuming default or economic catastrophe, investors might miss the meaningful upside that comes from resolution and soft landing. Extrapolating today’s concerns into the future can cloud the real opportunities that emerge beyond today.
Assuming debt ceiling resolution or economic prosperity in the near-term leaves investors overconfident in the road ahead. While such confidence pays off in the long run, it’s a challenging place to be in the midst of uncertainty and market volatility.
Fortunately, investors seem well prepared for uncertainty. The appeal of higher interest rates and concerns over the markets and economy have driven investors to park more and more cash in money market funds. For weeks, investors have been pulling cash from the market, swelling money markets to more than $5.3 trillion.
While much of that cash is being held for short-term spending, there’s also plenty on the sidelines waiting to come in and swoop up investment deals. Add in plenty more cash that has gone to Series I savings bonds, CDs and other now higher yielding instruments, and it appears that investors have been preparing for a slowdown for some time.
It’s always good news when investors aren’t taken by surprise. Even if uncertainty does bring markets down for a bit, cheaper prices and shifting expectations eventually bring that cash back to the best opportunity. As a result, cash on the sidelines serves as just another cushion to the downsides of the current crisis.
Brinkmanship challenges investor resolve, by Kyle Tetting
Banking on additional uncertainty, by Kyle Tetting
Separating politics from portfolios, by Joel Dresang
Making financial sense of “breaking news,” a Money Talk Video with Art Rothschild
Focus on fundamentals to face volatility, a Money Talk Video with Steve Giles
(initially posted May 26, 2023)