Default a ‘Black Turkey’ as Advisers Tell Investors Not To Sell

Thursday, 28 Jul 2011 05:39 PM

 

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As nerve-racking as he finds the debt-ceiling negotiations, Chris Rainbolt, 36, hasn’t shifted his portfolio in anticipation of a possible U.S. government default.

“It’s kind of like you’re standing on a cliff, and as long as you don’t fall off the cliff you’re fine,” said Rainbolt, who lives in Dallas and works in real estate. “If you do fall off the cliff, it doesn’t matter what you do.”

Rainbolt is among investors whose financial advisers are telling them not to sell their stocks or bonds as time runs out for Congress to pass a deal to raise the U.S. debt ceiling. Treasury Secretary Timothy F. Geithner has said the U.S. will exhaust options for paying all of its bills on Aug. 2.

“There’s really just not a whole lot that you can do,” said Paul Jacobs, who’s a financial planner based in Atlanta for Palisades Hudson Financial Group, which manages more than $1 billion and whose clients have an average of about $20 million in assets. “You can’t just put it all in a money-market fund, because then if there is a nightmare scenario there’s really nowhere to hide.”

Al Vazquez said he’s been holding more cash in his clients’ accounts than he normally would, in anticipation of the debt- ceiling debate coming to a head.

‘Black Turkey’

“I think there’s a 99 percent chance it will be satisfactorily resolved,” said Vazquez, an adviser with LPL Financial in Gig Harbor, Washington. “There is a potential for a black swan, or maybe in this case a black turkey.” A black swan is a difficult-to-predict event with wide-reaching implications.

The U.S. Treasury Department has said Congress must act by Aug. 2 to raise the nation’s $14.3 trillion debt ceiling or risk default. If lawmakers miss that deadline, the government won’t have money to pay monthly Social Security checks, veterans’ benefits and contracts with businesses, President Barack Obama said in a televised address on July 25. Interest rates on credit cards, mortgages and car loans would skyrocket, Obama said.

It may be too late for investors to take defensive steps because the time to do so is before a crisis, and because the effects of a U.S. default or downgrade on different investments is difficult to predict, said Robert Arnott, chairman of Newport Beach, California-based Research Affiliates LLC, which oversees more than $80 billion.

“We’re entering unknown territory,” Arnott said.

Risk Tolerance

Moody’s Investors Service placed the U.S. under review for a credit-rating downgrade earlier this month. On July 14 Standard & Poor’s put the nation’s rating on “CreditWatch,” saying there’s a 50 percent chance it will lower the U.S. credit rating within the next three months.

Talking to clients who are concerned about the debt-ceiling debate can be an opportunity to reassess their risk tolerance, said Jane King, president of Fairfield Financial Advisors, which manages $120 million for about 100 clients.

“If we’re at the right level of risk, stay put,” King said.

The Standard & Poor’s 500 Index declined the most in almost two months yesterday as a stalemate over the debt ceiling pushed the U.S. closer to default. The dispute over plans to cut the federal deficit has stolen investor attention away from an earnings season that has produced higher-than-estimated results at about 77 percent of S&P 500 companies that have reported so far.

The Chicago Board Options Exchange Volatility Index, or VIX, rose 14 percent yesterday to 22.98, the highest in four months. The index measures the cost of using options as insurance against declines in the S&P 500.

Investor Withdrawals

Investors withdrew about $6.8 billion from stock funds in the week ending July 20, the most in five weeks, according to the Washington-based Investment Company Institute, a fund- industry trade group. Money-market funds held by retail investors increased $3.5 billion that week as funds held by institutions decreased $28 billion. Money-market funds hold about $684 billion in U.S. sovereign debt and must generally hold highly rated short-term securities, according to ICI.

“We’re sticking to our mantra of hanging in there and not getting caught up in the noise of what’s going on,” said Jay Higgins, a client relationship manager at Minneapolis-based Riverbridge Partners, which has about $3 billion in assets under management.

One client wanted to move all of his investments into cash until a deal on the debt ceiling is in place, and Higgins persuaded the client not to, he said.

Buying Opportunity

The threat of a U.S. downgrade heightens the need for municipal-bond investors to diversify among states, said Richard Saperstein, managing director of Treasury Partners, a division of Chicago-based HighTower Advisors.

A lowering of the U.S. credit rating could lead to a downgrade of other securities such as municipal issuers and government agencies, Saperstein said.

“Downgrade or default might be a short-term buying opportunity because the markets are spooked by what’s coming,” Research Affiliates’ Arnott said.

Investors should consider increasing their allocations to commodities, inflation-linked bonds and emerging-markets stocks and bonds, Arnott said.

Debra Taylor said she’s increased clients’ allocations this year to precious metals and to certain currencies, including the Canadian dollar and the Swiss franc. Taylor, an adviser in Franklin Lakes, New Jersey, has not made any major moves in anticipation of the Aug. 2 deadline, except when clients have made specific requests.

Defensive Moves

“I don’t know, at this point, what we could do,” she said. Selling stocks “would be akin to panic selling, and when they pulled it together there would be a relief rally and our clients would miss out on that.”

Some advisers have made defensive moves. David Carter has increased his typical client’s allocation to alternative investments such as merger-arbitrage and managed-futures strategies to about 20 percent from about 10 percent during the last month. Those investments may perform better than conventional stocks and bonds in a volatile or falling market, said Carter, who oversees about $1.5 billion as chief investment officer of New York-based Lenox Advisors.

“It seems a bit cavalier to just assume a solution will be found, because the stakes are so high,” Carter said.

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