Next on the Agenda – Sequestration and the potential for rocky markets

I have recently returned from meetings in Washington DC and note that the mood is sour.  The Republicans vow not to give an inch on upcoming negotiations, feeling that they have already deviated from their “no tax” pledge.  Democrats, however, feel that more compromise is required – on the Republican side – and are determined to stand their ground too.

For investors, although the recent tax rate hikes and three-month debt-ceiling agreement have reduced some uncertainty, the next few months present numerous opportunities for legislative skirmishes and for market volatility.

Important Dates coming up

1. March 1, 2013: Automatic spending cuts (aka sequestration) loom.  The threat of automatic cuts of $1.2 trillion over 10 years (roughly $984 billion after interest costs are saved or, $109 billion in annual savings from defense and discretionary spending) was supposed to drive lawmakers to make the hard choices for a compromise – especially since they are holding their pay hostage to a timely agreement!  However, as of this writing it appears as though each party wants blunt cuts across the board – which is what sequestration does – as a cudgel to assign blame to the opposition.  While the stakes are high in terms of ideology and the size of government, the agreed $1.2 trillion in cuts over 10 years is relatively small potatoes. A curtailment of $1.2 trillion is not enough to credibly stabilize debt growth or the critical debt to GDP ratio.  According to the Congressional Budget office, the debt to GDP ratio will rise to roughly 77% by 2023 if lawmakers cannot come up with a combination of more spending cuts and revenue raisers. [See latest CBO report][1]  Why is the rise of debt worrisome?  Because levels of debt at 90% or higher are associated with a reduction of economic growth by around 1%.[2]
2. March 22, 2013:  Government financing has relied on a continuing resolution for the past 3 years instead of an actual annual budget.  Look for budget hawks in the House to drive spending cuts in exchange for spending authorization.
3. May 19, 2013:  The 3-month debt ceiling agreement expires.  While the Treasury can always resort to “extraordinary measures” to keep government running for 5-6 months, we may be facing a déjà vu of the volatility witnessed last December.

Good news or bad news? 

With each party spoiling for a showdown, staying positive seems an act of bravery.  But the contrarian in me believes that bad news may be good.   According to Pew research,  “reducing the budget deficit” is now ranked #3 in terms of priorities by 72% of Americans (up from 53% in January 2009.) [3] And while the annual deficit has narrowed to 5.3% of gdp (or $845 billion)[4], excess borrowing is still adding to our accumulated $16.5 trillion debt. [Go to usdebtclock.org to see a real time running tally of all American debt.]  Assuming that politicians operate according to their reelection prospects, greater consciousness by the electorate could and should persuade lawmakers to forge a working agreement with the president in order to avoid visiting their districts empty handed.

Things for you to consider when investing money

• While volatility may be an unpleasant feature of financial markets, investing regular dollar amounts periodically over a designated time frame (called dollar cost averaging) may mitigate your anxiety.
• If your timeframe is a long one, considering your strategic asset allocation should be your best guide.
• And remember, volatility can also bring the opportunity of lower prices and cheaper entry point into the market. If you keep an eye on valuations, volatility feels less threatening to overall portfolio worth.