Political Dysfunction

Political Dysfunction

A number of our clients have contacted us about the political dysfunction and its potential impact on the markets. In response, we’d like to share our current thinking and outline how it relates to our investment management methodology.

After months of being off of investors’ radar, political leaders in Washington returned to center stage last week with the government shutdown. Republicans are demanding that Obamacare be delayed for a year in exchange for the passage of a continuing resolution that would restore all federal functions. For their part, President Obama and the Democrats insist that only a “clean” continuing resolution maintaining current levels of spending will be acceptable.

The gap between the GOP and the Democrats remains wide, but something has to give. While the timing of a deal is very difficult to predict, we see two potential solutions to the current shutdown:  first, Democrats agreeing to minor changes to Obamacare – such as repealing the tax on medical devices and ending Congressional member and staff exemptions from its provisions (while leaving current spending levels intact); or second, the president agreeing to pursue post- continuing resolution budget negotiations to reduce spending, cut entitlements and close some tax loopholes.

The latter outcome has recently become more likely. More important for the economy, however, is that neither scenario would increase the fiscal drag in 2014. A broader budget deal would be more bearish for Treasuries and bullish for stocks as investors could finally rest assured that Washington will stay out of the markets’ way.

While the negotiations over a broader deal could take months, the uncertainty emanating from Washington will diminish once a continuing resolution is passed. We envision a decline in political tension similar to the one that occurred once President Clinton and Speaker Gingrich began legitimately constructive budget negotiations after 1995-96’s record-setting 21-day shutdown.

In the near term, however, investors are rightfully most concerned about the debt ceiling. Since the shutdown began, our view has become less negative in terms of the potential market risk. Both parties will do what it takes to avoid triggering a default or getting as close to the precipice as they did in August 2011.

Yes, the leaders remain very far apart and a deal is hard to envision at the moment, but two important points should be kept in mind. First, Speaker Boehner reportedly pledged that he would pass a bill to raise the debt ceiling with Democratic votes, if necessary. This is an important step back from the brink and suggests that he is cognizant of the risks of triggering a major market correction or economic contraction.

Second, the Republicans have offered several bills in recent days to assuage the pain of the shutdown. These partial spending bills have been rejected in the Senate and derided by President Obama. Yet the fact that Republicans are willing to offer some measures that lessen the pain signals that they will be inclined to approach the debt ceiling in a similar fashion. Both parties understand the massive potential economic costs of playing a game of chicken with the debt limit and that leads us to believe that markets will be spared the angst of an eleventh-hour solution.

In the end, we are confident that policymakers will raise the debt ceiling before the situation becomes threatening enough to warrant a significant equity correction. Accordingly, these events do not have a material impact on our 3-year forward-looking outlook.

That said, amid this short-term period of elevated volatility, we feel this is an excellent opportunity to revisit our firm’s formal Investment Process

Our Investment Process

Strategic Wealth Partners follows a sophisticated tactical asset allocation (TAA) strategy. The goal is to enhance the risk-adjusted returns of your portfolio by shifting asset allocations according to market conditions. The key to this dynamic process is identifying longer-term valuation discrepancies between asset classes and capitalizing on them to either increase return without increasing risk, or to lower risk without sacrificing return.

Investing With Us:

• Strategic Asset Allocation. We start by building a strategic portfolio based on your timeline, priorities, and goals. But rather than following a static allocation with only periodic rebalancing, we take a more dynamic approach.
• Best-in-Class Research. We partner with a select group of economic analysis firms, investment research firms, and hedge funds that provide us with daily, weekly, and monthly research reports. This in-depth, highly specialized research is continuous and ongoing, informing every investment decision we make.
• Trend Identification. Our advisors convene monthly to discuss the trends that are formulating in the current macroeconomic environment while also identifying the best ways to benefit from those trends.
• Tactical Allocation Shifts. When we identify opportunities and/or inefficiencies in the markets, we move quickly to take advantage of them. We overweight or underweight various asset classes, within specified parameters, based on an analytical assessment of their valuations.
• Stress Testing. Not only do we analyze current conditions, we consider possible scenarios that could trigger a market decline. Using qualitative analysis, we assess potential downside to stocks and bonds and the specific risk exposure in your portfolio. When vulnerabilities are exposed, we take steps to protect your investments.

Executing this disciplined process consistently has enabled us to strike a reasoned portfolio balance and meet our client’s risk and return objectives over the long term.

As always, all are always welcome to reach out to us with additional questions or concerns.