08.19 Balancing Act: Can Your Portfolio Handle Market Imbalances?

In recent weeks, the stock market has been volatile due to a string of events in China, Greece and over concerns about when the Federal Reserve will begin normalizing interest rates. Investors worry that the very low interest rates of the last few years have created imbalances in the financial system that will have to be worked out as interest rates normalize. More about imbalances later, but it is now timely to look at one’s investment plan and goals as we could see some bumps in the road over the next few months.

I came across an article from the CFA Institute by Arthur Zeikel who was president of Merrill Lynch Asset Management. It was written to his daughter in 1995, but I think the article is very timely. Here is a link to view the article yourself, but a couple of points stand out to me.

“Personal Portfolio management is not a competitive sport. It is, instead, an important individualized effort to achieve a predetermined financial goal balancing one’s risk-tolerance level with the desire to enhance wealth.”
“Be serious. Pay attention to your financial affairs. Take an active, intensive interest.  If you don’t, why should anyone else”
“Diversify. Asset allocation determines the rate of return. Stocks have beaten bonds over time.”
“You cannot eat relative performance. Measure results on a total return based on your own objectives, not someone else’s.”

This means that you should have an investment portfolio designed for your needs. Investment performance is important, but comparing your returns to the hottest mutual fund or hedge fund doesn’t give you the peace of mind that a properly diversified portfolio geared to your level of risk tolerance will. A high-risk portfolio can be exciting on the way up, but can be even more exciting (stressful) on the way down. Don’t chase yield and don’t chase performance.

Closing on imbalances. The Federal Reserve’s policy for the last few years of very low interest rates was designed to spur economic activity, employment and create a little inflation. To a large extent, it appears to have worked but also has created imbalances that will have to be worked out as interest rates normalize.

One area is in the oil markets. Easy access to capital, low interest rates and yield chasing by investors has resulted in too much investment capital going into shale oil and gas production and that investment has helped cause oversupply in the energy markets and prices to collapse. We are starting to see some of the casualties now. Samson Resources plans to file for Chapter 11 bankruptcy protection by mid-September. KKR led a $7.2 billion leveraged buyout of the company in 2011. The bankruptcy filing will likely wipe out the equity KKR and its partners invested in the company or about $4.2 billion.

As interest rates normalize, other imbalances may become evident and could affect the markets. The good news is that normalization of interest rates should mean that the economy is also coming back to normal from the great recession.

Make sure your portfolio can take the inevitable bumps in the road on that journey without stressing the driver out so much that he ends up in the weeds.

James Mathis, Managing Partner, Echelon Investment Management

Photo: Harris & Ewing