Market Faces Headwinds, but Sector Leadership Remains

On Tuesday we discussed the wall of doubt and it is still in play. What will it take to keep the markets moving in an upward direction? The discussion below is food for thought relative to the broad market moving forward.

1) Geopolitical risk remain for the markets overall as the issues relative to Europe and the Middle East are not resolved. The markets is currently not pricing in a risk premium these events generally demand. Why? The short term focus is on stock market momentum and it is like the little boy who cried wolf, they have been in the news to the point of creating a deaf ear. The focus is more a cataclysmic event versus progress toward resolutions. In the event of government action, they are non-existent. Unless it is critical governments are unable or unwilling to act. The current situation in Greece is a prime example of this issue. They are at the point of collapse financially, but they cannot commit to a deal relative to the bailout and solutions that are win/win. The US is unwilling to deal with a balance budget or the social program deficits. Iran is equally an issue for the Middle East as they continue to provoke Israel as the parties fail to come to any resolution. This is a problem in which the pressure continues to rise. Without resolutions each could be disastrous to the financial markets.

Has complacency risen to the point we are facing another financial crisis in the geopolitical realm. The pro-activity of the central banks is helping keep things at bay, but at some point the governments will have to get off the sidelines and make tough decisions. Liquidity is not the solution it is simply a stop gap to getting governments to act judiciously towards a resolution no matter how tough it is in the short term. The current economies will not sustain a shock of these based on the current conditions. Fiscal budgets are stretched too far and the overall financial stability is not on sound footing.

2) Sustainable economic policies in the US, Europe and Asia that don’t include the Central Banks creating more liquidity. Federal Reserve Chairman Bernanke wants to be involved until 2014. Is that too long? It is important to recognize that the zero percent rates are causing collateral damage to pension funds, retirement savings and money markets. They have not been a catalyst for the housing, financial or global markets. Thus, at some point we have to weigh the benefits versus the costs or come up with alternative solutions.

How long do the central banks remain engaged? There is plenty of debate by the investment community, but we are feeling the effects already. Investors are being forced to abandon ‘safe’ asset classes for higher risk assets to keep pace with inflation and have enough money to meet financial obligations. The number of underfunded pension funds are growing as a result of the 8% return projections used to calculate investment by companies. The pension shortage is creating a another burden on the financial systems short term.

Housing, infrastructure and fiscal policies of government haven’t moved to make progress since 2008. Yes, we can blame party politics, but the need to put aside childish ways and move forward is essential if we are to build a foundation for the advancement of growth in the US financial markets, housing and infrastructure. Inactive government leaders remain a point of issue for the market looking forward.

3) Getting the cash off the sidelines. Investor tolerance for risk will have to increase if the markets are to sustain the upside move. Investors will need to develop confidence in the strategies for growth moving forward. There is a distrust of the system in place relative to both Wall Street and the government regulations and over involvement. Investors are become more prudent in their willingness to accept risk. In fact, they are willing to accept little to no return currently on assets versus putting them at undo risk.

The key to building a successful portfolio over the long term is patience and unfortunately that is a challenge in today’s economic environment. When we create government policy focused on now without consideration for longer term ramifications you extract confidence from investors. Nonetheless, investors are now being patient on the side of waiting for the all clear signal in the financial markets.

Having options when it comes to managing the process of asset allocation. Investors and advisers alike understand the need to diversified among the different asset classes, but they also understand the need to manage the risk more actively of each asset class. Thus making a decision relative to the weighting of each asset class to their portfolio. For example, being under weight equities relative to the current conditions is prudent. Being equal weight to commodities long term and being patient through the volatility periods as demand is not declining for these assets. Shortening bond exposure to 5-7 year maturities to dampen risk in the event of financial issues globally or domestically impact interest rates. Putting money to work in the financial markets is a process not an event. Practice prudence in building and allocating money to risk. Be patient with the process of managing money, it is a marathon not a sprint and allocate assets in accordance with your risk tolerance. Don’t over commit your money to risk understand the process before you invest.

There are plenty of obstacles to the progress of the markets and financial systems globally and domestically. They will all evolve over time. The key is to be aware of surroundings and make investments accordingly.