3rd Quarter, 2013 Review and Outlook

October 1, 2013

Drama on Capitol Hill Boils Over

The drama we’ve been witnessing on Capitol Hill has spilled over in the financial press so that makes for a good starting point in this quarter’s summary.  A partial shutdown of the federal government began today, Oct. 1st, and the U.S. Treasury is nearing its capacity to borrow. We’ll start with the shutdown. The situation in the nation’s capital is fluid and a deal could quickly emerge, but as it currently stands, both sides are far apart.

The atmosphere on Capitol Hill has been anything but genteel, there is no budget in place, and the government needs what’s commonly called a ‘continuing resolution’ if non-essential services are to continue. The continuing resolution may last for just a few weeks. In that case, we’d need another resolution at expiration. Or it could go for as long as one year.

Without an authorization for new spending, certain non-essential services came to a halt today. Government workers were furloughed, national parks were closed, and any attempt to get a passport suddenly became a big hassle. But Social Security, Medicare, military service, and the mail go on.  How might the problem at hand be resolved? Possibilities include: give and take on both sides, one side could blink if political pressure becomes too intense, or a short-term solution is crafted.

Investors seemed to be preoccupied with other matters today, however, as major U.S. stock indices produced gains, with the NASDAQ Composite leading the way due to a strong performance by Apple.  The fear of a possible Government shutdown seemed to disappear in light of its reality today.

During the 3rd quarter most major asset categories saw gains except for long term U.S. Treasury bonds.  Major stock indices, high yield corporate bonds, international bonds, gold, silver, and commodities all produced positive results this past quarter. (Morningstar, Inc.)  This helped our portfolios increase in value as well across the various risk levels over past three months.  We still see a possible “topping out” of the stock market moving forward, and have remained with below average exposure to stocks in general for all our risk levels.  Given what still lies ahead this year, we feel there is undue risk in stocks vs. the potential reward for the balance of 2013 and moving into 2014.  We will continue to monitor this on a regular basis and keep you informed of any changes that might occur.

30 year mortgage rates dropped from a high of 4.70% on July 5th to a current rate of 4.28% as well, which could help revive the recovery in real estate as we enter the 4th quarter. (Bankrate.com)

Reaching the Debt Ceiling

The U.S. Treasury is also running up against its ability to borrow. According to the latest report, the Treasury Department expects to run into the debt limit by October 17; the Congressional Budget Office anticipates a breach somewhere between Oct. 22 – Oct. 31 (WSJ). The possibility the U.S. might technically default on its debt is a more worrisome possibility, as there are no precedents, and we would be entering uncharted waters.

The last time we had a bruising debate over raising the debt ceiling occurred in the summer of 2011, which led to a downgrade of the U.S. triple-A credit rating by Standard & Poor’s and plenty of volatility in U.S. stocks. However, the debt limit debate shared the stage with a U.S. economy that appeared to be stalling and a debt crisis in Europe that threatened to sink the euro.  Odds still favor some type of agreement to raise the debt ceiling since setting sail into uncharted waters of a technical default brings about a whole new set of unwanted risks.

If no agreement is reached, some have suggested the U.S could prioritize payments, such as interest on the national debt, social security, national defense, etc. Others argue that with hundreds of thousands of invoices paid annually, the government has no system in place to sequence outlays. Markets would prefer not to test that hypothesis.

Fed Surprises, Delays Taper of Bond Buys

In addition to some of the uncertainty created by the drama in D.C., antics by the Federal Reserve have also influenced markets.  The Fed doesn’t set rates on longer-term bonds, but its policy has influenced returns on everything from Treasuries to municipals to lower quality bonds (also called junk bonds or high-yield).

The Fed’s goal is fairly simple. It hopes that low interest rates encourage businesses and consumers to spend and borrow. It also hopes to encourage activity in the housing and equity markets, boosting prices and hoping wealthier consumers spend more. By hoping to encourage economic activity, businesses are more likely to hire. Only then would the Fed consider raising interest rates, helping savers earn higher returns.

Besides holding the fed funds rate at near zero, the Fed has been buying $85 billion in longer-term Treasury bonds and mortgage-backed securities each month (popularly called quantitative easing or QE for short). Its goal – buy the bonds, push up the price, and lower bond yields.

Many had expected the Fed to start the “tapering” process after their September 18th meeting.  It was a surprise to the markets when the Fed announced the continuation of their full bond buying program and no real hint as to when they may start to taper moving forward.  Their reason to continue at this time was to point to a recovery that wasn’t quite measuring up.  Further, the Fed highlighted that it was worried about the sharp uptick in mortgage rates, and it was concerned about the looming budget battles in Washington. (Fed statement following the September meeting).

This leads us to the next Fed meeting on October 30. Will we get a trick or a treat from the Fed? Much depends on the economy and how long the budget battles in Washington drag on.

 And You Thought Healthcare Costs Have Skyrocketed!

The following chart illustrates the comparison of costs for various categories since 1985.  As you can see, college costs have been out of control, almost doubling the increase in medical care costs.collegecosts

Your TEAM at F.I.G. Financial Advisory Services, Inc.

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