What Could Go Wrong?

Last week I shared with you the reasons why I believe the market has rallied despite all the current negative news. Many readers were pleased to understand my thinking on why sentiment is so high for investors when news is so bad. There were also some that wondered if I ever considered what could go wrong to damage investor sentiment.
 
At Destination Wealth Management, we are by nature paranoid as we invest in portfolios. That's why we have positioned assets as we have and why we tend to avoid assets that are highly speculative despite possible positive outcomes. We want to see companies demonstrate earning potential prior to investment.
 
This perspective for investing is combined with our belief that you can really never know what the economic future will look like (and how it will affect investor sentiment). I can think of countless things that could go wrong that could damage the economy and the markets. We consider these possibilities as we make investment judgments.
 
As a counterbalance to last week’s update, I thought it might be helpful to look at the other side of the equation: 
 
What things might go wrong that could damage not only the economy but investor sentiment. All of the items I am listing could occur. 
 
Here are seven issues that we believe could damage the market and the economy.

• Virus uncertainty: What if the virus news is overly optimistic and the impact of advancing vaccines and treatment is not positive? What if side effects are far greater than people imagine? What if the virus mutates and a vaccine only lasts three months or six months? What if a large percentage of the population chooses not to take a vaccine when it comes to market and shutdowns still occur?
• Political turmoil: What if the upcoming presidential election is disputed? What if a large part of the electorate chooses not to believe the election outcome? What if future legislative agenda is negatively impacted by a cloud hanging over the administration because some believe the election was illegitimate? What if there is a 50% chorus constantly complaining about the illegitimacy of the election as a way to undermine legislative activity?
• Policy and legislative certainty: What if a change in administration and legislative balance results in huge shifts in tax policy? What if changes in public policy create uncertainty for industries thereby slowing capital expenditures and company optimism? What if corporate earnings are negatively impacted because companies are concerned about future tax policy?
• International turmoil: What if China's economy begins to slow significantly and emerging markets economic activity collapses? What if European bickering turns into real economic problems and the European Union begins to dissolve? What if Germany's leadership changes and a new government chooses a different path in its relationship with the European Union? What if Germany decides not to support weaker European Union members?
• Economic stagnation: What if economic recovery doesn't happen as predicted? What if the new normal is 7% unemployment, a depressed commercial real estate sector, a slowdown in economic growth, and a higher percentage of the American population remaining perpetually unemployed? What will that mean for consumption in the US economy? How will that impact retailers that sell products in the United States?
• Federal Reserve risk: What if the Federal Reserve policies lead to hyperinflation? What if the Federal Reserve cannot stimulate the economy enough to save the US from a significant economic downturn? What if governmental action is in conflict with federal policy response thereby minimizing the impact of the Federal Reserve? What if Congress limits the ability of the Federal Reserve to act independently?
• US debt: What if the consequences of the current US deficit become greater than many expect? What if the US dollar is significantly weakened to the point where a new reserve currency is contemplated for global trade? How will the United States ever pay back its deficit? Will the country be able to operate successfully with $25 trillion of deficit spending on the books?

All of these questions we have thought through and consider as we develop investment strategy. We also recognize that events that are unforeseen (beyond what has already been mentioned in this update) could emerge. The only thing for sure is that clarity is impossible.
 
Our more conservative investment strategy is based on our belief that items listed in this update could potentially play out; it’s important we consider that possibility. We will continue to keep you updated as our thinking evolves, and we make new and updated judgments on the economy and markets.
 
Being overly optimistic can be very dangerous in investment strategy. Being somewhat paranoid can provide some balance. However, being overly paranoid and pessimistic can be damaging to investment strategy as well. It’s about the right balance.