Dr. Peter Venkman: This city is headed for a disaster of biblical proportions.
Mayor: What do you mean, “biblical”?
Dr Ray Stantz: What he means is Old Testament, Mr. Mayor, real wrath of God type stuff.
Dr. Peter Venkman: Exactly.
Dr Ray Stantz: Fire and brimstone coming down from the skies! Rivers and seas boiling!
Dr. Egon Spengler: Forty years of darkness! Earthquakes, volcanoes…
Winston Zeddemore: The dead rising from the grave!
Dr. Peter Venkman: Human sacrifice, dogs and cats living together… mass hysteria!
Mayor: All right, all right! I get the point!
– Ghostbusters (1984)
If you turned on the business channel today, you might have seen a certain network compare the potential repercussions of the ongoing debt-ceiling debate in Washington to a scene from the movie Ghostbusters. In fact, if you were watching CNBC today, you did see a clip of this:
First, we’d like to state our track record on political handicapping as it relates to the well-publicized debt ceiling debate. In 2011, while others we’re saying to run for the hills, we encouraged our members to stand their ground in July of that year via ‘Ignore the Debt Ceiling News, Focus on Corporate Earnings.’ We summarize that piece below:
In all, we think the market should pay less attention to the debt-ceiling issue and more to corporate earnings, which have been pretty strong almost across the board. Our outlook on the market is positive, and the goal (of) our Best Ideas Newsletter (portfolio) is to continue to build on our outperformance relative to the S&P 500 in future periods. We think the S&P 500 has more room to run higher…
Members that remained focused on the key driver behind long-term stock prices, corporate earnings, did incredibly well by heeding our call in July 2011, as shown below.
However, this time IS different, in our view. We’re not at all confident that the debt ceiling debate will go away anytime soon — the more likely outcome in this case is that the panic will once again be extended, perhaps by 6 weeks or maybe longer. We find it entirely ironic that as Barack Obama warns Wall Street, the market continues to move higher. These conditions are eerily similar to those that led to many money-managers getting burnt during the Financial Crisis.
At that time, even high-profile fund managers thought many of the banks would survive the crisis, so all they had to do was just buy them at a discount to book and wait for the other side of the cycle (like they had done before successfully). The only problem with this strategy during the Financial Crisis was that many banks didn’t make it to the other side of the cycle, and those that did had to issue dilutive equity to stay afloat (depressing total returns).
The debt-ceiling debate of 2011, the resulting 11th-hour agreement of that episode, and the massive stock rally that followed has created a sense of reassurance in the investment community that everything will somehow be alright. Such a stance, in our view, is unfounded. With stock valuations now significantly stretched (see: Keeping Some Dry Powder), there’s no longer underlying valuation support for the broader equity markets to move higher as they did since 2011 — when all of our significant outperformance in the Best Ideas portfolio was generated.
We’ll be watching events closely during the next few days (the deadline is October 17), but one thing is clear — we remain focused on achieving the return goals of our Best Ideas portfolio, and we’re well-positioned to do so. For example, should the market rally from here in the event that the debt-ceiling issue goes to the background for an extended period of time, we’d expect the constituents of our Best Ideas portfolio to continue to lead the outperformance gap higher — as they have done through the rapid stock market run-up thus far in 2013. However, in the unlikely case that there is a large market disruption from this particular debt-ceiling debate, we expect the return on our put option on the S&P 500 Select SPDR (SPY) to significantly increase and the large cash position in our portfolio to help lead to even greater relative outperformance. Said differently, we’ve structured our portfolio in such a way that we’re hoping for the best but are prepared for the worst.
Though we’d much rather focus on corporate earnings and valuations, we cannot ignore political uncertainty. Yet, in any scenario, we believe the best of times are still ahead for Valuentum. Stay tuned, our friends!