<b>Editorial:</b> Preparing clients for a low-return reality
Our nation's economic recovery stands pretty much where it started off six months ago: improving, but not fast enough.
As they usually do at midyear, many investment management firms are offering their outlook on the economy and markets for the next six months. This year, the consensus view is one of tempered optimism, with expectations of slow economic growth, modest and selective im-provements in equities, and interest rates remaining low.
That outlook is comforting, but given the uncertainty surrounding so many situations around the world, as well as our all-too-familiar experiences with theoretically rare “black swan” events, now is a time for financial advisers to be especially vigilant.
Despite 2012’s getting off to a strong start, our nation’s economic recovery stands pretty much where it started off six months ago: improving, but not fast enough.
More than likely, as many analysts and strategists are predicting, the economy will grow in the second half, but at a pace likely to be uninspiring. Last week, in fact, Federal Reserve Board Chairman Ben S. Bernanke said that the central bank’s Operation Twist efforts to drive down long-term-interest rates will be extended through the end of the year to help ensure that growth, albeit slow, continues.
UPHILL CLIMB
But slow growth does not assure a smooth glide path for equity prices. Due to the continuing crisis in Europe and political dysfunction in Washington, equities, though cheap by historical norms, face an uphill climb in the second half of the year. Even though the outlook for stocks is positive through year-end, advisers may want to begin preparing their clients for lower returns.
The outlook for the bond market also is uncertain.
Top-rated sovereign bonds, investors’ first choice for safe income, continue to generate record-low yields. As a result, more investors — particularly retirees who depend on savings for income — are driven to add higher-yielding debt to their portfolios. In doing so, of course, they are taking on more risk.
Given its fragility, the nation’s economic recovery is vulnerable to a vast array of risks.
One of the biggest, of course, is Europe.
While the results of the Greek elections suggest that the nation’s exit from the eurozone is not imminent, Greece’s fundamental problem — namely its massive debt burden — remains unresolved.
But Greece isn’t Europe’s only trouble spot. Bank failures and a collapse of the banking systems in Spain and Italy — certainly within the realm of possibility — would send shock waves throughout the global financial system.
Advisers also should look beyond Europe for potential crisis points that may affect their clients’ portfolios.
Consider, for example, China.
After years of impressive expansion, China’s economy, as measured by gross domestic product, has slowed dramatically. There is the possibility that China’s GDP growth may fall below 7% in the second quarter, which would mark the weakest quarter of growth in three years, and the sixth consecutive quarter of slower growth.
For U.S. investors, the slowdown in China’s economy is worrisome. While the top three U.S. export categories to China (power generation equipment, oils and seeds, and electrical machinery) account for only about $29 billion in trade (compared with the $216 billion accounted for by the leading imports (electrical machinery, power generation, and toys and games), a slowdown in China would chill world trade. That would add another obstacle to our economic recovery.
The economic flash points are not just international.
While the U.S. housing market is showing signs of improvement, that improvement is weak, spotty and could be derailed easily.
THE “FISCAL CLIFF’
Then there is the “fiscal cliff,” that fear-inducing phrase intended to describe a confluence of changes in tax and federal spending measures coming to a head at the end of the year. Unless current law is changed, taxes will rise by $600 billion, while federal spending will drop by $130 billion — potentially sending the economy into a free fall.
Out of concern that Congress won’t reach a compromise in time to avoid the economy’s going over the cliff, some companies — particularly defense contractors — already are putting the brakes on hiring and spending. Consequently, some analysts are predicting that U.S. growth will slow to 1.3% in the third quarter.
If the one-two punch of a tax increase and a spending cut does occur, advisers likely will find themselves preparing their clients for a full-blown recession in 2013.
Times like these present planners and advisers with great challenges.
But they also present them with great opportunity. Now is the time for advisers to demonstrate the value of their training and experience, as well as their focus on looking out for their clients’ interests.
By being prepared to adjust their clients’ financial plans to accommodate even the most unusual events and circumstances, advisers prove to clients that they take their role as financial guardians seriously.
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