Stocks did well in the third quarter as the Federal Reserve and the European Central Bank came to the rescue once again. To the surprise of many investors, U.S. stocks are entering the fourth quarter of the year within striking distance of all-time highs.
3rd Quarter Results:
Driving those gains was the Federal Reserves powerful money machine and its decision on September 13 to continue to buy government debt which would pump more money into the economy. In addition, the European Central Bank declared that its latest plan was to buy government debt of some of its beleaguered nations to lower those nations’ borrowing costs. These two measures gave investors new confidence to take on more risk, e.g. buying more stocks, and the markets continued to go up in September.
Many individual investors have missed this run-up, afraid to get back into the market. However, we have taken full advantage of the market’s good return this year.
The stock market always faces problems. Currently, consumers are more confident but aren’t spending much. Fewer people are losing their jobs, but not many are being hired. Home prices and stocks are rising but workers’ pay is trailing inflation. Auto sales have jumped, but manufacturing is faltering. This is what an economy stuck in slow growth looks like. The U.S. economy grew at an anemic 1.3% in the 2nd quarter of the year, too weak to reduce high unemployment. Most economists foresee little if any improvement the rest of the year.
Many Americans are reducing debt loads instead of spending as in the past. Home builders are borrowing less and building more modest homes. Businesses are being cautious about hiring and expanding. These trends will eventually help our country recover and get stronger. For the time being, however, these weak numbers hurt everybody.
One of the major issues facing the stock market and the U.S. in general is the approach of the “Fiscal Cliff”. This is the term that is being given to the problem the U.S. government will face at the end of 2012. This is when the terms of the Budget Control Act of 2011 are scheduled to go into effect.
Among the laws set to change January 1st, 2013 are the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers). In addition, it is the end of certain business tax breaks, shifts in the calculation higher for the alternative minimum tax, the end of the tax cuts from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to take effect. This will affect over 1,000 government programs including military spending.
U. S. lawmakers have three options:
1. They can let the current policy scheduled to go into effect in 2013 actually take place. This would result in a substantial slowdown. The Congressional Budget Office predicts that the economy would go into recession by losing -0.5% and that 2 million jobs would be lost. Taxes would increase for 90% of the population and the family earning $40,000-$60,000 per year would see a tax increase of $2,000.
The positive coming from this option would be that the deficit as a percentage of GDP would be cut in half.
2. They can cancel some or all of the tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to Europe. The flip side is that the debt would continue to grow.
3. They could take a middle course, opting for an approach that would address the budget issues to a limited extent, but that would have a more modest impact on growth.
This oncoming fiscal cliff is a concern for investors since the highly partisan nature of the current political environment could make a compromise difficult to reach. This problem, of course, is not new. Lawmakers have had three years to address this issue, but political gridlock has put off any resolution. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve, particularly in an election year. The most likely result is that the problem will linger at least until after the election and there’s a strong possibility that Congress won’t act until the 11th hour.
The most likely outcome is another stop-gap measure that would delay a more permanent policy change until 2013 or later. The election will most definitely have an impact, especially if there is a decisive victory by one party. Nevertheless, the CBO estimates that if Congress takes the middle ground by extending the Bush tax cuts and eliminating the budget cuts, in the short run there would be modest growth with no major economic hit.
This uncertainty may affect the course of the stock market in the final quarter as investors do not like uncertainty, particularly when it comes to taxes.
All the mutual funds our clients are invested in were positive for this period. We are happy with the return their portfolios have made given the conservative nature of the allocations. If your allocation is not performing well, give us a call.
Have a great fall!
Bruce A. Kraig, MBA, CFP
October 6, 2012
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