While many American families celebrated the official beginning of summer, those of us charged with maintaining their portfolios were hanging on the news each day as it was released. It was a rocky go, and while the month may have ended (finally), we still have much to watch as the events of June 2011 play out in the months ahead. So… you may be thinking, ‘What in the world did I miss?’ In the spirit of enjoying summer, I’ve written summaries of each event below.
End of the American Investment and Economic Recovery Act
$480 billion in federal stimulus ended last month (not counting extensions which will continue through August) as part of the act which was passed during the latest recession. This funding has subsidized states through the economic downturn. As is typically the case with “found” money, states have grown more dependent on federal subsidies, and pre-June 2011 were relying on the stimulus to fund almost 30% of their budgets. Like a parent cutting funding from a child, this is expected to cause a large learning curve as legislators struggle to make up the distance between the amount in the coffers and the amount on paper.
State Budget Deadlines
Among other things threatening economic recovery in our country, state finances are particularly pivotal. While states in recent months have seen stronger than predicted revenue growth, large fiscal problems still remain. States are still seeing revenues of roughly 9% below pre-recession levels, and 42 of them are looking to close a cumulative $97 Billion (0.65 of the GDP) in budget shortfalls for FY 2012. Kansas is facing a $492 Million projected shortfall for FY 2013, which makes up 8.1% of the general fund at 2011 levels. Missouri’s projected deficit is larger than that for FY 2013 at $792 Million, which makes up 8.9% of its general fund. While shortfalls are leading lawmakers to decrease funding of basic services, the larger issue is that covering debts (including state pensions) is becoming increasingly difficult. Pensions will likely take a hit in many states, and while we’ve already seen this a bit, I expect it will continue to make headlines as politicians jockey for rank in the coming election year.
Bonds, Treasuries, Stocks, and Decisions….
Let’s take a walk backwards…The Fed wants interest rates low. We know this because they have stated as much. They have also played their own ponzi scheme in expanding the money supply to epic levels to buy treasuries. One purpose in buying treasuries is to keep rates low. Low rates allow the “too big to fail” banks to stay around longer, they keep mortgage rates lower, help levitate stocks, and supposedly help businesses. The problem is the Fed has stopped treasury purchases as of 6/30/2011.
The image above outlines the dynamics of the see-saw analogies. In the first image, we have the stocks to bonds see-saw showing the inverse relationship between stocks and bonds. In the second image we have bonds and their price to yield inverse affect. Note that bonds must be down in the left image and up in the right image. How on earth can that happen? “Fed Magic” would be the answer. In a true price discovery environment, buying bonds would be a negative to stocks because it would reflect investor preference over stocks. In this Fed “goosed” environment, the Fed has been the buyer freeing up (forcing by way of punishingly low rates) investors to look elsewhere. In essence, they are breaking the see-saw on the left allowing stocks and bonds to be up at the same time. This is why you hear some market realists state that the stock market is levitating.
Since the Fed is ceasing the purchase of new bonds, investors who do not like the yield (interest rate) they are offered by the treasury, will ask for higher yields. Rising yields spell lower bond prices, and lower bond prices means higher stocks. But, rising rates will really crush the economy in the short and medium term, which would tank stocks. In a way, letting rates rise now would lend to the reverse of the current unnatural condition we find ourselves in. Instead of rising bond prices and rising stocks (what we have now) we will end up with rising rates and falling stocks (a formerly unnatural condition). The dilemma for the Fed is going to be how to keep rates low. They have two choices which are let stocks tank, or start buying bonds again.
The above section is from my Weekly Market Commentary, but I believe it bears repeating. If you find it informative and would like to read it in its entirety, subscribe to receive it in your inbox, or want to forward it on to someone else, click here.
Debt Talks in Washington
Most importantly, we are all awaiting the August 2nd deadline facing Congress regarding the debt ceiling. Much to investors chagrin, we did not see much action from the federal government in June. Bi-partisan talks are at a standstill as both sides work to uphold party values, and the American economy is hanging in the balance. While they work to come to a decision, investors are choosing to hold on to their money to see what materializes in the coming months. For those people hoping to see the economy recover quickly, it seems we’ll have to wait for a measure to pass before spending increases once again.
The true outcome of June 2011 will likely play out over the next year as services are cut at the state and national level; the jobless rate increases and/or stays stagnant; companies look to move their operations to tax-friendly states; and food prices continue to rise. Federal Reserve Chairman Ben Bernanke went on record in June stating “we don’t have a precise read on why this slower pace of growth is persisting…” This leads me to believe that top government agencies are scrambling, and we may be on the verge of QE 3 (Quantitative Easing 3), or something very similar. During QE1 and QE2, the government reacted to budget shortfalls by literally printing money and pumping it into the economy. Historically speaking, this causes inflation, and we are feeling the effects now. I hope that we don’t see QE3, but I’m not optimistic that people are ready to face the hardship that is needed to truly get our financial lives back on track. I believe that an end to the debt ceiling talks (whatever the outcome) will help to boost our economy as people will begin to feel more secure about their personal finances and ready to invest again.
As I’ve said in the past, my investment strategy seeks to avoid sharp losses. I am always looking for great buying opportunities for my clients, but at the same time I stand ready to hold a percentage of cash in my client’s portfolios if it’s the only sensible option to avoid losses.
Do you have an investment strategy that seeks to protect your investments from sharp losses? Call me to schedule a free review of your current investment portfolio – 913.693.7918.
John P. Chladek, MBA, CFP® is the President of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals. For more information, visit http://www.chladekwealth.com.