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Irrational Pessimism

The stock market over the past two weeks has left investors moribund with declines in some indexes exceeding 20 percent from the year’s high — official Bear Market territory.

While stocks worldwide took significant hits in the wake of the debt ceiling negotiations, the coup de grace was the downgrade of U.S. Treasuries by Standard & Poor’s a week ago. Now that we have lost our coveted AAA rating by at least one agency, what does this mean for our economy and your portfolio?

Certainly the last month has not given us confidence in our national government’s effectiveness. If our country’s self-inflicted wounds weren’t enough, we face additional challenges. How are we going to get the economy off the ground?

Growth in GDP was about 1 percent annualized last quarter. Growth it may be, but it’s not at a level to create jobs as unemployment continues to hover at 9.1 percent.

Market watchers are hoping for QE3 to sail. Quantitative easing in the form of the Fed buying Treasuries has helped lately by keeping interest rates low, thus providing stimulus to the economy in the form of cheap credit, although it’s doubtful that QE3 would have much impact with rates already below 2.4 percent on the 10 year Treasury.

Corporations and, to some degree, householders have plenty of money. They’re just not spending it.

While an accommodative monetary policy may have lost its punch, its decline in popularity doesn’t rival stimulus — a four-letter word for many in this country. It’s apparent that neither Congress nor the president is in the mood for Keynesian-style intervention in the form of additional government spending.

While there are plenty of reasons for pessimism, we need to understand that this is nothing like 2008. Corporate balance sheets were relatively weak back then, especially banks and insurers, due in part to mortgage-backed securities that ended up being worthless.

Household savings had turned negative and debt was exacerbated by bubbly borrowing against depreciating homes. Our economic growth was mostly due to financing and building houses for people who couldn’t afford them.

Now corporate profits continue to impress and make up a larger percentage of national income than any time since World War II. Household balance sheets are on the mend with personal savings rates exceeding 5 percent, up from zero or worse a few years ago. What’s notable is that this cash is retained by corporations and households at a time when it pays essentially nothing.

While the S&P downgrade did alarm the world, ironically there has been a huge rally in the price of Treasuries. The bond market has processed this news and has promptly run the other way as the so-called experts.

In fact, the negative review of U.S. creditworthiness strengthens the hands of deficit hawks in the upcoming budget process. We may end up on a path of greater fiscal stability with this pressure.

All of this high-level speculation and macroeconomic analysis may be the topics of the day, but what impact does it have on your portfolio and the decisions you must make?

Of course our first instinct is to react to this market plunge. Once we see the data about individual investors released for August, I’m sure we’ll see they sold equity mutual funds in droves.

Staying the course and holding steady may seem like dated bromides lacking relevance in today’s adrenaline-pumped global market.

But if you found yourself wanting to push the panic button a week ago by liquidating hundreds of thousands in equities based on a hunch, take a deep breath and find an investment strategy that enables you to sleep at night without caving into your primordial fears.

Dave Gardner, for the Daily Camera.