The Good, The Bad and The Ugly

The Dow’s down almost a 1,000 points since this government shutdown began, but who’s counting? For movie buffs, and budding financial farmers, there’s a classic scene in The Good, The Bad and The Ugly aptly termed a Mexican Standoff which puts our current situation in context. Clint Eastwood, Lee Van Cleef, and Eli Wallach each have the other in his sights, yet no one can make a move. This is what our economic, political, and social situation has devolved into; a true Mexican Standoff, and as anyone familiar with the movie knows, whoever shoots first loses.

What’s so troubling about our current dilemma is that just two weeks ago we had seen the Dow near all-time highs, the NASDAQ had recovered nicely to just under 4000, and the S&P 500 had climbed over 1700. All were very important metrics to the investor's psyche. Interest rates remained low, inflation was tame, and while not altogether spectacular, unemployment was creeping down. There was absolutely, undoubtedly, positive progress since the dreary days of March 2009 when as any investor can attest, even your puts were loosing money! All of this has come to a grinding, gridlocked halt just when many Americans were starting to see the light.

This is what makes investing so challenging, knowing that we’d probably be better off liquidating our entire portfolio and then waiting out the next couple weeks in cash; yet the problem arises of predictability. It is usually just about that time where you feel like throwing in the towel that the market makes a dramatic comeback. It’s a double whammy, you end up selling at the recent lows and are too cautious going back as the rally goes further. This scenario has played itself out time and again, and is precisely why I’m a champion of the Invest Like A Farmer philosophy.

By definition, when you Invest Like A Farmer your seeds are planted for the long-haul and the capital you invested is not rent, mortgage, or emergency savings. It is seed capital you have deployed in the expectation of compounded returns years, many years, into the future by specifically investing in companies with special characteristics. They are boring in the sense that boring is sexy; they are typically monopolies with significant barriers to entry selling products that are exclusive, finite, hard-to-get, vital, and/or addictive. These companies also typically pay you to own them, and usually every quarter. Generally they are high margin, high volume going concerns with a steadily moving higher and higher left to right stock chart. These are the type of assets we like to buy and let grow.

Sadly, even the best companies with the cleanest balance sheets and most promising products, brands, and customer base are no match for a government that fails to function. There is little remedy for a stalled democracy except patience and the next election cycle.

50/50 Chance of a U.S. Debt Default Presents Perfect Black Swan Scenario

I've raised my estimate of a U.S. debt default from a 0% unthinkable chance to an even 50/50. We're a week into a government shutdown with no compromise in sight. Nearly every pundit has the debt default scenario pegged at 0% (including me, up until last night.) This brings to mind all the elements of a black swan event.

Popularized by the philosopher/poet/economist/trader Nassim Nicholas Taleb in his 2001 book Fooled by Randomness, a black swan event "is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme 'impact.' Third, in spite of its outlier status, human nature makes us concoct explanations of its occurrence after the fact, making it explainable and predictable."

These elements seem to correlate well with where we're at right now in regards to the debt ceiling. With nearly every expert predicting a 0% chance of a default happening and a political system that is behaving ineffectual at best, the days tick by and nothing is accomplished. What has materialized is the slow motion proverbial train wreck you can't take your eyes off of, but this potential disaster has a significantly wider zone of destruction.

I think the two most meaningful impacts are going to be a major hit to the reputation of the United States and the second is a direct hit to investment portfolios because Wall Street cannot stand uncertainty; the latter I think will recover promptly as the catalysts of a bull market are still firmly in place and I would like to believe our elected officials wouldn't ruin the republic. The reputation hit is another thing though, as it builds on what has become an increasingly stalemated government system.