The U.S. stock market hardly missed a beat in its upward climb to new highs in the third quarter. Despite continued uncertainty about the health of the global economy and the future of monetary policy, U.S. stocks retook all-time highs in the quarter before falling back slightly at the end of September.
3rd Quarter Results:
The market’s focus was definitely on the Federal Reserve again this quarter. At its September meeting, the Fed chose to keep in place its current program of purchasing mortgage-backed securities. This was seen as a major surprise given that the central bank had spent the last several months hinting that a taper was imminent. Fed chairman Ben Bernanke cited mixed economic data and the uncertain path of fiscal policy as the primary reasons for not yet taking the foot off the accelerator. The Fed is still broadly expected to begin tapering in the coming months, but the lack of a clear timetable has likely been causing some stock and bond market volatility.
The focus on the Fed contributed to some fairly large moves in the Treasury market. The yield on the 10-year bond started the quarter off at 2.5%, rose to nearly 3.0% as the market anticipated the tapering announcement, and the fell back down to 2.6% after the central bank’s surprise move.
The U.S. economy continued its slow but reasonably stable growth in the third quarter. Despite some initial fears, the economy has not been derailed by higher interest rates.
Manufacturing is strengthening on the back of better auto sales and consumer spending has held up fairly well. The housing market appears to be getting weaker, however, as mortgage rates rise.
Going Forward in 2013:
We were correct in our assessment last quarter about rising stock prices. Despite the strong performance we are still faced with major problems including Fed policy timing, government shutdowns, and the debt ceiling debate.
The collective impact of the government shutdown is expected to be small. It was estimated that the WashingtonD.C. area would lose more than $200 million a day during the shutdown, largely in lost income for federal workers. This has changed however as the House passed a bill recently that would pay employees for their time at home. It will be a paid vacation. In addition the Pentagon called back almost all of its employees saying they provided direct support for the active-duty military.
The issue of the debt ceiling is potentially more serious. The government could run out of money to pay its bills as soon as the middle of October if Congress fails to raise the borrowing limit. Treasury has said that the cash it now has on hand will run out completely on November 1, leaving the government in essence without money to pay its bills. That would undermine global confidence in the United States as the world’s financial safe haven and could permanently increase the nation’s borrowing costs.
Major credit agencies have said they might consider the U.S. in default if it fails to pay its bill. Many economists have warned that there could be a major slowdown in the economy, with job losses along with a rise in interest rates affecting credit cards to home mortgages. Other fears are that foreign investment in U.S. Teasurys and the dollar would dry up over worries about lost returns.
Federal debt is the amount of money the government currently owes for spending payments such as Social Security, Medicare benefits, military salaries and interest on the national debt. It is not future debt, however. The debt limit simply allows the government to finance existing legal obligations that Congress and past presidents have made in the past.
The debt ceiling idea came about in 1917. Before then Congress had to approve borrowing for each item when the government needed money.
In order to have more flexibility as the U.S. entered World War I, lawmakers at that time agreed to give the government approval for all borrowing as long as the total was less than a specific number. That debt limit number would be set by Congress.
Whenever the government is going to exceed a debt limit, meaning it needs more funding for current debt, Congress has to vote its approval to raise it. As of October 2013, the debt limit is $16.7 trillion. Since 1960, congress has acted 78 times to permanently raise the debt limit.
So certainly, this is not something new. However, there is currently more resistance to raising it without concurrent changes to government spending this time. This is the rub.
We cannot believe that Congress and the President will not come to some compromise relative to the debt limit. There is too much at stake not to do so. However, there may be some volatility before this is accomplished. We ask you not to be too concerned about it. The markets will look beyond this temporary problem.
Investment Strategy 3rd Quarter:
We continued to be more aggressive with many clients' portfolios this quarter. We again moved additional dollars out of bond funds into equities. We expected bonds to do worse than equities in the third quarter and this was certainly the case. Bonds have treaded water this quarter while equities moved up about 6-7%. This was definitely the correct thing to do and we are very happy we did it.
Many portfolios have exposure to healthcare and small-cap stocks. Healthcare was up 30% through nine months while small-cap stocks were up 28%. Other equity funds are up less but have done exceptionally well so far this year. Most portfolios have more risk now than they did at the beginning of the year. However, as the market has trended upward we have responded to that move and reacted by putting more dollars into those areas that could benefit from a surging stock market. This strategy has worked very well.
There is always uncertainty in the markets. We will make additional adjustments if necessary as we move through the fourth quarter.
Bruce Kraig, MBA, CFP
October 4, 2013
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