“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.” — Donald Rumsfeld, Former U.S. Secretary of Defense
Greece and China have both been in business headlines in June, reminding me of Donald Rumsefeld’s famous quote about known unknowns. It is widely known that Greece may exit the Euro, and as I write this column news has broken that Greek banks will be closed on Monday and capital controls imposed in the country in response to the deepening crisis. It is also known that in response to a slowing economy and recent two week selloff in its stock market, the Chinese government has cut its benchmark lending rate to a record low and is pursuing increasingly accommodative policies. Those are the known knowns.
In my August post I recommended investors do nothing in terms of stocks. In my view as we end the year, stocks still represent a good value in terms of dividend yields versus bonds, and an investment portfolio should hold a healthy portion of stocks. The S&P 500 index of large cap U.S. stocks is yielding more than ten year Treasuries. So despite the volatility I didn’t argue for selling, but neither did I argue for aggressively adding to stock positions given legitimate concerns about European debt issues. I found it worrisome that the earlier stock rally had broken down, and plausible that a volatile stock market could move any direction—higher, lower or sideways. And for the year it basically did move sideways. But the value and lack of good investment alternatives in my mind argued for doing nothing and holding onto positions.
It is increasingly clear that the arrangements at the center of the world’s monetary system are fraying. On Monday Standard & Poor’s cut its outlook on the credit rating of the United States to negative indicating there is a very real possibility for a downgrade. By Tuesday gold prices topped $1,500 an ounce. Also last Friday China admitted inflation was picking-up steam, as it announced an official annual uptick of 5.4 percent that almost surely understates the true amount. On the European front Moody’s downgraded Ireland’s credit rating last Friday. That action followed earlier comments from Germany’s finance minister that Greece may default on its debts. All of this came despite the world being in the midst of an economic recovery.