As the debt ceiling debate drags on we are faced with some tough decisions from an investment standpoint. The medical profession has a standard often expressed in the Latin phrase “primum non nocere,” which translates to, “first, do no harm.” According to the omniscient Wikipedia, it is a fundamental principle for emergency medical services around the world. Another way to state it is that “given an existing problem, it may be better not to do something, or even to do nothing, than to risk causing more harm than good.”
We apply the same principle here at Iron Capital. Over the last several days we have spent considerable time, energy and effort in discussing the possible scenarios in this debt debate and how we should best protect our clients. In every scenario, we ask: what if we are wrong?
We have considered shorting Treasuries. This is, after all, the source of the problem. If Treasuries are downgraded or worse yet, go into default, they should lose value rapidly. To a large extent this should already have occurred and it has not. Some have even suggested that the dominance of the thoughtless risk-on/risk-off traders could even cause Treasuries to rally, since the panic over their downgrade would cause people to sell stocks – even though they are not directly impacted – and buy Treasuries – even though they are the problem. I know it is insane, but it is also a reasonable probability given the recent market behavior.
Another probability is that we do get a deal (by the way this is the highest probability) and the announcement of the deal causes Treasuries to rally. If either of those scenarios plays out, shorting Treasuries would have done more harm than good, not what we want.
We have considered shorting the stock market. The issue here is that a rally is likely when a deal is announced, and while not an absolute certainty, a deal is the highest probability. There is also the factor that many stocks look very attractive now from a fundamental standpoint. If politics were not a concern, we would not be considering shorting. It is uncharacteristic for the CNBC talking heads to make any good points, but one did yesterday when he commented that portfolio managers are good at analyzing fundamentals of companies and identifying long-term investment opportunities; they are not good at figuring out what a bunch of politicians are going to do. I would humbly include the professionals at Iron Capital in that description. We could do more harm than good.
We considered going to cash. The problem with going to cash is that you have to know when to go back. Returns in the stock market come in bunches. If you miss even one really good day, your long-term results will not be nearly as good as the person’s who stays invested. If we saw a prolonged bear market coming it could be a different story, but that is not the case. Bear markets are all about price-to-earnings ratios; one of those things has to collapse. In the tech bubble it was the price, and in the Great Recession it was the earnings. Today neither of those things seem to be occurring. This is more of a short-term phenomenon caused by political anxiety. Timing that is beyond our skills. Once again, we could do more harm than good.
So what are we going to do? We are going to wait and see. Sometimes that is the right and most courageous thing to do. We will be prepared to act should events transpire that shed more certainty to a potential prolonged bear market, but in the interim we will trust in the long-term supremacy of fundamentals over the short-term macro-economic noise. That has never let us down before, and it is unlikely to do so this time.
Chuck Osborne, CFA