Fragasso’s Portfolio Management Department is a team of seasoned professionals that establish allocation guidelines and provide asset class recommendations to help build our clients’ customized portfolio solutions. The team also produces market analysis, commentary and special reports on the global economy for our clients.
With these great resources on staff, we tend to receive a lot of questions. We want to keep the conversation going! Submit a question below to our team. Your question could be answered in an upcoming blog or on our new radio show, The Advisor!
Here are three of the more recent frequently asked questions:
1. How does the US national debt affect the decisions of the Fragasso Portfolio Management team?
During and after election season, politicians from both sides of the aisle raise awareness of the national debt with a far greater frequency than is normal. Over longer-term history, however, both parties have proven to be fairly poor at actually materially reducing borrowing, as it is far more palatable to increase spending than to raise taxes. This contributes to a spiral whereby government debt increases over time. An adage often is said that one could not run their household like the US government does, perpetually spending more than they earn and being dependent on added borrowing to cover the interest payments. While true from a long-term perspective, we have to bear in mind that the time frame that households can run this way is far shorter than the government, and the difference comes down to the ability of the government to always find buyers of their debt, given that the US remains a relatively better credit risk than other sovereign issuers.
This topic is somewhat tricky to discuss in a short blog post, mostly because the topics raise a lot of additional issues that require explanation. For the sake of brevity here, we would point out the following things. First, the biggest owner of the US government’s debt is… us! Based on data from early 2016, the US owns 67.5% of its own paper1. For the US government, this means willing buyers are present for the foreseeable future. Second, it should be noted that external investors still view US bonds as a relatively safer area to park capital, and it does not hurt that US government bond yields actually pay something, however modestly.
We would be remiss to not point out, however, that government debt has been growing faster than gross domestic product. This is a large issue to deal with, especially when coupled with other burdens on the government’s budget (i.e. entitlement programs). Unfortunately, this likely means it’s going to be harder to generate outsized economic growth in the near term, and the dollar is likely to be worth less in a few years versus itself, which has been the case since World War II. Investors cannot forget, however, that currencies have a relative value as well, and the path for the US dollar to appreciate versus other currencies is a potential investment implication we consider when constructing our portfolios. In our view, this creates a potential limit in the near term to how far longer-term interest rates can materially rise, which leaves us less optimistic about returns across equities and fixed income in the coming years, particularly with starting valuations where they are today.
2. Given some of the problems in the European Union (EU), and the apparent unhappiness of some EU countries, do you think the EU will dissolve in the foreseeable future?
There are plenty of countries who are not fully pleased with the state of the European Union, and the parties within each country that are calling for exit from the EU are still growing. The fact that the UK economy has done rather well since Brexit has only emboldened some. However, the will from some of the EU countries, like Germany, Poland, and Luxembourg, to keep the club together is strong, and predictions of further exits to follow Britain’s seem to be overblown. The UK was always slightly different than most other major EU countries; the euro is not their home currency, and since they are separated from mainland Europe by the North Sea, many British never felt they had strong ties to Europe. Additionally, the remaining members of the EU will almost certainly make the terms of leaving very difficult for any exiting country.
Though our base case is that the EU remains intact, if we take the other side and assume the union dissolves then there will most certainly be economic and market implications. Slower global growth may be one outcome as trading agreements between each country will need to be established. The disbanding of the EU will also most likely result in higher inflation. As Europe would move towards a protectionist environment where trading with other countries slows, goods will become more expensive which will drive up inflation.
Despite the headlines that rocked 2016, European equity markets have forged ahead in 2017, implying that economic growth may be stronger than initially understood.
3. What steps are in place to safeguard against a downturn like in 2008?
Seek uncorrelated investments. Emphasis is placed on finding uncorrelated, or less correlated, investments. This is what potentially bolsters portfolios during times of market stress. In this globalized world where financial markets are inextricably linked, a phenomenon has been observed during market crises where correlation of even diverse assets approaches one. This makes it critical to consider an investment’s role in a portfolio context during both normal and volatile market environments.
Invest abroad. Investing in other countries is an effective way to diversify your portfolio and your ordinary income. We live in a globalized world, so macro data in the United States can still have an impact abroad and vice versa, but there are many other economic factors that drive foreign markets unrelated to the United States. Investing in other economies will not only diversify a return stream, but it may also provide exposure to growth opportunities not available in the US.
Utilize volatility-mitigating assets. Portfolios should often include an allocation to volatility mitigating assets, particularly when equity and fixed income valuations are elevated. These investments tend to have a beta of less than one, relatively low standard deviations, and low correlations to traditional asset classes like equity and bonds.
Analyze an investment’s performance during a crisis. Once the dust had settled, extreme events like the Financial Crisis are great case studies for stress testing portfolios. This was a learning experience for even the most skilled and seasoned portfolio managers to identify flaws and poke holes in their methodologies in effort to make improvements.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. No strategy assures success or protects against loss. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
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