Market Commentary - 1/4/13: Happy New Year and it’s back to business!

I have always been a big fan of Calvin and Hobbs comic strip. As a result, I believe the above caption is pretty funny, and unfortunately probably represents how many of you view our politicians.

  

As I noted in prior commentaries, the fiscal cliff was avoided and the deal struck placated Wall Street, but does not fundamentally address the U.S.'s budget deficit and spending issues. This will come to the forefront since the U.S. government reached its legal borrowing limit on December 31, 2012. Congress has until February 28th before it must raise the debt ceiling or risk causing the government to default on its bills and financial obligations. As a result, yesterday's market rally may be somewhat tempered in the weeks ahead, as both sides go to battle on what agreements need to be reached so that the U.S.'s debt limit is increased.

Overall, 2013 may pan out to be a decent year once we get beyond the debt ceiling debate. On a historical basis, stock prices are trading at reasonable levels based upon the current P/E (i.e., stock prices versus what the companies' earnings are), and as I have mentioned before, there are still mountains of cash on the sidelines waiting to be invested.

The major concern facing us now is the U.S.'s deficit and its credit rating. If the former increases, without practical steps taken to address it, then the latter will decline. As such, it is a foregone conclusion that at some point interest rates will increase. This is due to either economic growth or a declining credit rating for U.S. bonds.

I believe the Federal Reserve is doing all it can to keep rates down, but eventually, either later this year or sometime in 2014, interest rates will increase. At that point, bonds, and most specifically, long-term bonds (i.e., maturities of say 20-years +) will see declines in value. Thus, the warm fuzzy feeling that many investors have received from holding bonds will start to evaporate.

Their choices will be to either try to ride it out, which could take years, or go to cash, stocks, other equity-oriented investments, precious metals or real estate. For those investors who need a current income, discernment will be needed since precious metals don't generate income, and even though you can find income producing stocks and real estate, neither are without risk.

Please note that I am not saying that investors need to abandon all bonds. Just that your bond allocation may be less than it was in the past, and/or you will need to be open to other forms of bonds. Other types of bonds include corporate, floating-rate, inflation-protected, convertible and overseas bonds. In addition you'll need to consider dividend paying and preferred stocks.

Based upon the Federal Reserve's policy of low interest rates, this change in your bond allocation may not need to be considered for at least a year or so. In addition, this change should not be feared. Just as there is a changing in the seasons from fall to winter and then spring to summer, various investments become either more or less attractive based upon changing economic cycles.

Even though I cannot tell you what kind of deal or on what date they'll eventually hammer out regarding the debt ceiling, I can tell you that interest rate risk is something that we are keenly aware of and have either taken and/or will be taking steps to address in the near future.

Meanwhile, I hope you and your families are off to a good start in 2013.

Quotes

“He is happy whose circumstances suit his temper, but he is more excellent who can suit his temper to any circumstances."

                   David Hume

"When you find yourself stressed, ask yourself one question: Will this matter in five years from now? If yes, then do something about it. If no, let it go.

                   Catherine Pulsifer

Tony Moeller, CPA

The information listed in this commentary is a compilation of various publicly available sources and is for informational purposes only.  It is not a recommendation or solicitation of any particular investment or strategy.  A risk of loss is involved with investments in the stock and bond markets.

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