Investors were spoiled for choice for things to fret about yesterday.
There was Europe, of course. Even as economies across the region continue to crumble, politicians can’t seem to agree on a way forward. They’d rather stick to throwing blame at each other.
Trouble is, it’s becoming clear that the same story applies to the US. Politicians there can’t seem to agree on anything either. A committee set up to try to form a deal on spending cuts completely failed to come up with any decisions.
With so much dependent on what politicians – and their central bankers – decide to do next, these aren’t easy markets to navigate.
Here’s what we recommend you do.
The super-committee did its job – it wasted lots of time
Everyone knows that committees are a waste of time. Committees are not meant to produce action. They are a handy space for parking problems that politicians (or managers) have no intention of dealing with.
So it stands to reason that a super-committee is just a repository for a super-big problem that no one has any intention of dealing with. And in that sense, the super-committee set up by US politicians in August did its job perfectly.
The goal was to find some common ground on austerity measures for the US – the Republicans and the Democrats were meant to agree on how to reduce the country’s annual deficit (overspend) by $1.2 trillion.
In reality, it was just another delaying tactic by politicians. As it turns out, they haven’t reached any agreement, and now they can play the blame game with each other until election day.
What are the consequences? The obvious one is that the $1.2 trillion is now meant to be cut from spending automatically. A big chunk will come from defence spending, which won’t be popular. But these cuts won’t kick in until 2013, so there’s plenty of time to fiddle the rules before then.
The real worry – and what bothered markets yesterday – is that if a deal isn’t reached, it makes it a lot harder for Barack Obama to extend various tax cuts that expire at the end of this year.
With the outlook for the US in 2012 already ropey, higher taxes would just make a recession even more likely. Indeed, RBC Capital Markets reckons that if a temporary payroll tax cut (enacted in December last year) is allowed to expire, it will cut US GDP growth by one percentage point in 2012.
As for Europe, the situation continued to deteriorate, with credit rating agency Moody’s warning about France’s AAA-rating being under threat.
How do you invest for a market like this?
Markets are rebounding this morning from yesterday’s slump. But don’t expect it to last. At heart, this is all about extreme uncertainty.
No one is taking charge of the situation in the US or Europe. That makes it hard to predict what might happen next. So betting the lot on a simple stock or bond index is just too risky. The potential outcomes here are just too different.
For example, if the European Central Bank (ECB) agrees to print unlimited sums of money, there’ll probably be a huge rally in equities and eurozone sovereign bonds. But I’d expect US Treasuries and gilts to slide.
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If eurozone countries start to leave or get kicked out of the single currency club, there’ll probably be a huge slump, and quite possibly a panic. Equities would dive, but US Treasuries and to a lesser extent, gilts, would probably rally.
Those are pretty much ‘red’ or ‘black’ outcomes. Bet the pot on one or the other, and if you get it wrong, you’ll lose out big time.
So you have to be picky. Rather than tracking the market or worrying about what governments are doing, look for strong businesses that can thrive almost regardless of the outlook for the economy. And buy them when they get flogged off on the down days.
As one Australian fund manager tells Bloomberg, “Quality businesses will be sold off unreasonably, and you have to be on the lookout for every opportunity you get. By the same token, in the current market, a stock rally will be quite hard as well”.
One way to take maximum advantage of the market’s mood swings is to use investment trusts. These are listed companies whose business is simply to buy other companies.
Because they are stock exchange listed, the price of shares in investment trusts fluctuate with supply and demand, rather than consistently tracking the value of the assets they own. This means that sometimes – and this is one of the main reasons we like them – you get the chance to buy the underlying assets for less than they’re worth. When this happens, the trust is said to be trading at a discount to net asset value (NAV).
When markets are feeling panicky, as they are now, you’ll sometimes find that trusts overshoot to the downside. In other words, the discount will widen as investors sell off hard on the bad days.
So build a list of trusts you like the look of, and aim to drip-feed some money into them on the down days. We had a list of some of our favourite investment trusts in MoneyWeek magazine a couple of weeks ago – subscribers can read the full piece here: Seven reasons to buy investment trusts. If you’re not already a subscriber, subscribe to MoneyWeek magazine.
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