Tag: Markets

Market commentary as we begin the fourth quarter of 2013

As the third quarter of 2013 came to a close, focus turned to Washington with the government shutdown and the looming November 1 debt limit.  As we write this, it remains to be seen how the competing factions will come to a resolution or if they’ll just end up kicking the can down the road, as they have done so many times in the past, without making any real compromises on the underlying issues.  From 1976 to 1996, the government shut down 17 times, spanning a total of 110 days.  Historically, government shutdowns have had no detectable long term effect on the markets.  The last, and longest, shutdown doesn’t appear to have hurt the economy.  That was mid-December 1995 until early January 1996, a three-week shutdown under President Clinton.  The year before the shutdown, real GDP grew 2.3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  In the fourth quarter of 1995 it grew at an annual rate of 2.9{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} and then during the first quarter of 1996 it grew at an annual rate of 2.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  This was despite the shutdown and the East Coast Blizzard in January 1996, which was then followed by large floods.

While headline news will have short term effects on markets, over the long term, economic conditions and the direction of corporate profits will have the greatest and most long-lasting effects on portfolios.  Economic conditions have been slowly and steadily increasing over the past few years, and now Europe seems to have stabilized and may be beginning to experience modest growth.  China’s new leadership is working to transform that country’s economy from being export-oriented to one that is more focused on increased consumer consumption.  This will have a major impact on the future of global trade.

As we have said for several quarters now, we continue to remain optimistic about stocks and cautious on bonds.  Even though the Federal Reserve has indicated that they will not begin easing until the economy improves, and they have spelled out what they’ll consider improvement, just the mere mention by the Fed of future rate hikes sends bonds tumbling.  As we said last time, we think that the Fed being able to remove itself from the equation of the U.S. recovery is a net positive, not a net negative.  Additionally, we now have the November 1 debt ceiling looming, which could send both stocks and bonds oscillating as politicians and pundits take to the airwaves to bring a little “Halloween cheer” (sarcasm alert).  We think a last-minute deal will be struck to avoid any real damage, aside from the emotional toll imparted upon people who watch the news or the stock markets very closely.

Whatever comes our way, we are always positioning our portfolios to participate in further market gains and to cushion any market declines.  Over the long term the trend is up.  Please call if we can be of any other assistance to you or someone you care about.

How Does a Government Shutdown Affect Investments?

The stock markets do not like uncertainty and a government impasse leading to a partial shutdown leads to uncertainty.  People begin asking questions like: How long will it last?  Who will be affected?  What are the long-term consequences?  The day before the shutdown that began October 1, the Dow Jones Industrial Average fell by 129 points.  Traders said that the markets had been anticipating the political gridlock, which had contributed to the Dow’s recent slide.  The day the government actually shut down, the same index rose 63 points because positive economic news impressed investors more than the shutdown.

Despite the size of government and the number of people they employ, the economy as a whole has a much greater effect on the markets than a shutdown.

During a shutdown, money still flows into the Treasury Department via things like tax receipts and it still flows out via things like Social Security and interest payments on Treasury Bills.  The military, weather service, food inspections, border control, air traffic, prisons and even the U.S. Postal Service (“Neither snow, nor rain, nor sleet, nor hail, nor government shutdown shall keep the postmen from their appointed rounds”), they all keep operating.  And as long as the Treasury Department still has flexibility, it still pays the debt as it comes due without missing a beat.  The interest on the debt runs about $220 billion while tax revenues exceed $2.5 trillion, so there really is not a chance that the U.S. government will actually default.

The government purposely tries to make a shutdown much more painful than it really has to be by, for example, closing the National Mall, the World War II Memorial and other open air monuments and attractions in Washington, D.C., in an effort to get the public to put pressure on Congress to reach a settlement.

But if you need a passport or want to get into a national park (via a park entrance, anyway), you are out of luck.  Non-essential federal workers get furloughed and non-essential services stop.

You’ll surely hear certain analysts, pundits and politicians saying a shutdown will hurt the economy, but if history is any guide that is hard to prove.  Recently, The Washington Post listed every shutdown – there were 17 of them from 1976 to 1996, spanning a total of 110 days – and of those 110 days only 6 were during a recession.  That’s very few considering that the U.S. was in a recession about 14{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} of the time during those twenty years.

The last, and longest, shutdown doesn’t appear to have hurt the economy either.  That was mid-December 1995 until early January 1996, a three-week shutdown under President Clinton.  The year before the shutdown, real GDP grew 2.3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  In the fourth quarter of 1995 it grew at an annual rate of 2.9{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} and then during the first quarter of 1996 it grew at an annual rate of 2.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  This was despite the shutdown and the East Coast Blizzard in January 1996, which was then followed by large floods.

Remember the dreaded sequester?  It was forecast to be an economic and political disaster.  Today few people actually remember it because most never felt it.  Paradoxically, the real result of sequesters and shutdowns may be the realization by the public that the government is spending and wasting too much, and that political wrangling by the two parties in charge does not help the economy and may actually hurt it.  In the late 1990s, that reaction slowed government spending relative to GDP dramatically and the U.S. eventually moved into a surplus.

In other words, if you look back at history and didn’t know beforehand when the government was in a shutdown, you would be hard pressed to ever figure it out.  Keep this in mind as politicians, journalists and pundits work overtime in the coming days trying to scare investors and the public with the ramifications of keeping the government shut.  In more ways than one, it may be a good thing.

With rising interest rates, what to do about bonds.

With interest rates increasing investors are noticing that their bonds are not doing nearly as well as their stocks.  In fact many investors may have lost money on bonds this year.  For example, the typical tax exempt bond fund has lost between 4 – 5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} year-to-date.  What should investors do about bonds when the likelihood of rising interest rates is high?

The October issue of Financial Planning magazine give us an insight into what happened in the past when interest rates rose.

During the five-year period from 1977 through 1981, the federal discount rate rose to 13.42{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} from 5.46{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, an increase of nearly 800 basis points, or 145.8{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. During that period, the five-year annualized return of U.S. T-bills was an impressive 9.84{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  But T-bills are short-term bonds.

But bonds did not fare nearly as well. The Barclays one- to five-year government/credit index had a five-year annualized return of 6.61{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, while the intermediate government/credit index had a 5.63{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} annualized return. The long government/credit index got hammered amid the rising rates, and ended the five-year period with an annualized return of -0.77{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. Finally, the aggregate bond index had a five-year annualized return of 3.05{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.

As every investor should know, bonds go down in price when interest rates go up but that decline is offset by the interest paid on the bonds.  If an investment manager knows what he is doing and protects his portfolios by avoiding exposure to long-dated government bonds the results will be acceptable. An annualized return of 5.63{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} is quite good when rates are increasing.

But one important note: It does not seem prudent to avoid bonds entirely during periods of rising interest rates. Bonds are a vitally important part of a diversified portfolio containing a wide variety of asset classes – during all times and seasons. Rather than trying to decide whether to be in or out of bonds, the more relevant issue would seem to be whether to use short-duration or long-duration bonds.

This, of course, is consistent with a strategic approach to portfolio design. Rather than completely remove an asset class from a portfolio, advisors and clients would be well advised to thoughtfully modify the components of an asset class. To use a nautical metaphor, rather than swapping boats, we simply trim the sails.

 

Government shuts down, markets rise.

The market does not like uncertainty and as the House and Senate ping-ponged bills at each other yesterday, the markets sold off.  But as the reality hit that there was not going to be a last-minute compromise and the sun rose in the East, people realized that a government shut-down in a free-market economy is not a financial Armageddon.   So at the opening bell, the US stock market rose, as did many markets around the globe.

From the Wall Street Journal:

Stocks rose, shrugging off the first U.S. government shutdown in 17 years, helped by a strong reading on manufacturing activity.
The Dow Jones Industrial Average advanced 63 points, or 0.4{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 15191 in recent trading. The S&P 500 tacked on 11 points, or 0.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 1692, and the Nasdaq Composite Index rose 29 points, or 0.4{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 3800.
Global stocks showed resilience after lawmakers failed to reach agreement to keep the government fully funded to start the new fiscal year as Senate Democrats and House Republicans remained at loggerheads over government spending and the launch of the Affordable Care Act.
Traders said that the markets had been anticipating the political gridlock, which has contributed to the Dow falling seven over the past eight sessions, including Monday’s 129-point slide.
“Most people are pretty sure that this is going to be a short-lived event,” said Ian Winer, director of equity trading at Wedbush Securities. “Even though there were big moves leading up to this, most people are positioned for a near-term shutdown, and it looks like the selling has let up. There’s not a lot of new buying, but guys have sold what they wanted to sell.”

There is an old Wall Street adage: “Buy on the rumor, sell on the news.”  That simply means that an event that is widely anticipated is probably priced into the market by the time it actually comes to pass.  That seems to be what happened in case of this much-anticipated shut-down which, it seems, was actually wanted by both sides.

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