Don’t Panic

As of the close of business yesterday, the Dow Jones Industrial Average was down 1,136 points, or 6.8%, since the end of 2013. The venerable average was down 5.3% in January, which lead many seers to warn that the market would therefore be down for the full year. I’m here to disagree with that sentiment. I believe that this is simply a long overdue correction in a bull market that began in March 2009 and remains in place today.

Quite simply, the fundamentals underpinning this bull market remain in place. Corporate balance sheets remain pristine and profits continue to grow. The Federal Reserve remains committed to keeping interest rates artificially low and will inject liquidity into the system at the first sign of danger. Congress has already passed a budget deal and is likely to approve an amendment to the debt ceiling without a protracted fight. And finally, the economy continues to grow, albeit at a somewhat modest pace. All of this suggests that the stock market should again move higher.

Keep in mind that there are relatively few alternatives to an intelligently constructed stock portfolio when it comes to saving for your future. Interest rates at the bank are actually negative when viewed after taxes and inflation. Government debt is not much better. Corporate debt generally has positive yields, but you’d have to extend the maturities too far into the future to reap any reasonable yields, and in doing so you would incur significant interest rate risk. On the other hand, there are many solid, blue-chip stocks that pay annual dividends of 3% or better and are increasing those payments at rates far better than inflation. Good examples include Pfizer (PFE), Verizon (VZ), Proctor and Gamble (PG) and Chevron (CVX). [Disclosure: All four stocks are among the Top 25 positions held by Werlinich Asset Management] And while you enjoy those dividends, you also have the possibility of long-term capital growth.

For example, defense giant Lockheed Martin (LMT) pays a dividend that yields 3.5% at the current price. And the stock has tripled over the past ten years, which represents an average annual growth of about 12% per year for the past decade. While there is no guarantee the stock will continue that rate of growth for the next ten years, if it only grows at half that rate, the stock could double over the next decade, not including the dividend payments. What bond can give you the same growth potential? [Disclosure: LMT is the 3rd largest position held by Werlinich Asset Management.]

When looked at through a longer term prism, an intelligently managed stock market portfolio remains the best option available in order to save and invest for long-term growth and future financial security. 

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When Good News Is Really Good News

The Department of Labor today announced that the unemployment rate in October dropped to 7.0% as 203,000 new jobs were added in the month. Almost 300,000 fewer people were counted as unemployed while the labor force participation rate increased, both of which are good things. In addition, the average work week increased a bit, as did average wages. To sum it all up, this was probably the best employment report since the beginning of the financial crisis in 2008.

In recent months, this type of good economic news was often seen by the market as bad news because it suggested that it would force the Federal Reserve to accelerate its timetable to begin tapering QE. Following that logic, without QE to prop up the stock market, equity prices would fall. This convoluted thinking has left us with the backwards reality of “bad is good” and “good is bad” for the past few months.

So as an investor, where does today’s action leave us? At this moment, the Dow Jones Industrial Average (#DJIA) is up 193 points to 16,015. It could be that stock market participants finally understand that it’s good to have better employment; that it’s a good thing to have better than expected GDP growth (the second estimate for Q3 was 3.6%) and that the housing market should not collapse with the 10-year treasury around 3%. I believe that the Fed will not begin to ease before April. And if they do it right, they can reduce their monthly bond purchases slowly enough that it shouldn’t do any real harm to the economy. Indeed, if the economy is strong enough to stand on its own, that’s good for everyone, including the stock market.

Therefore, my clients and I remain fully invested in the market. I expect this rally to extend through the rest of this year and into 2014. And if the rumor is true that Congressional leaders are inching closer to a bi-partisan budget deal on the debt ceiling and the deficit which will include getting rid of the harsh sequester cuts, then we could really be looking at a very bright picture for the stock market for months to come.

The Market Still Doesn’t Care That The Government Is Closed

We are now in the third week of the government shutdown and we’re careening towards the first “deadline” of October 17 with no deal in sight. By that day the Treasury will reportedly have about $30 billion with which to pay its bills. That will leave less than two weeks to scrimp and scrounge before the next big deadline of November 1, at which time the government will no longer be able to make social security, Medicare, pension and other benefit payments. Then, on November 15, the government could default on about $30 billion worth of interest payments due to bondholders. Most rational market observers, meaning those not affiliated with the Tea Party, believe that defaulting on these obligations would be catastrophic to the market.

So why is the stock market within shouting distance of its all time high? Why is the VIX (volatility index) displaying nothing but complacency? To me, the answer is clear. Stock (and bond) market participants believe strongly that a deal of some kind will be reached sometime this month After that the government re-open for business, the debt ceiling will be raised and the Treasury will pays all its bills as promised. In all likelihood, this will be simply a short-term fix, meaning that in a few short months we could very well be right back in this perilous situation all over again. But that will be a story for another day. All traders care about is that the current crisis will very likely be averted.

So what does that mean to investors? It means you should remain invested. Now is not the time to bail on the market. In fact, you should use temporary market dips to add to your holdings. The Federal Reserve remains highly accommodative; and that means the party in the stock market is likely to continue for at least the rest of the year.

Personally, I put some money to work first thing Thursday morning, as the huge two day rally began. As word leaked that an accord could be forthcoming, the market soared. As it turned out, the rumors were just that, and there was no deal. Yet the rally demonstrated how much buying power is waiting on the sidelines, ready to jump in when an agreement is finally reached. Interestingly, the market opened down 100 points today as investors expressed their disappointment in the lack of progress over the weekend. Yet as trading closed ten minutes ago, the Dow Jones Industrial Average was up 64 points. This is simply a market that does not want to go down.

So if the market doesn’t care that the government is closed, you shouldn’t either. Surf’s up; time to ride the wave.

Will the Republicans Actually Close the Government?

At midnight on Monday we will find out if the hard-liners within the Republican party (read: the Tea Party) will follow through on their threat to close the government as they refuse to negotiate in good faith on a deal to expand the debt ceiling. Whether one agrees with ObamaCare or not, I think it’s reprehensible that the right-wing members of the Republican party led by Congressman Ted Cruz of Texas, seeks to draft policy after losing the election, rather than focus on what is important right now: ensuring that the government can pay its bills. Now is not the time for extreme partisan politics. Now is the time for statesmanship; for cool heads to find common ground and a compromise that is in the best interests of the country.

I’ve ranted countless time in my newsletter, this blog and my twitter feed about the gutless and selfish sycophants that pretend to be our leaders in Congress. I won’t bore you by repeating the same withering criticisms. Suffice it to say that these morons are once again holding America hostage as their inability to put aside partisan politics in order to draft a federal budget leaves us a scant three days shy of a partial government shutdown. I can make an argument that, in certain circumstances, it wouldn’t be a bad thing for the government to close for a while. I do believe that we’d all be better off with a much small federal government. But that’s a conversation for another day. In this case though, it would be a very bad thing for all concerned. I still hold out hope that a deal will be struck before October 1 as our Congressional leaders are concerned first and foremost with their own re-election, and to be blamed for shutting down the government won’t help any of them at the ballot box.

As I write this about 30 minutes after the market opened for trading on the last day before the weekend, the Dow Jones Industrial Average is down about 100 points thanks to all of the uncertainty regarding the fight to raise the debt ceiling and agree on a budget for fiscal 2014. The Treasury Secretary has stated that the government will run out of money no later than October 17 and will thereby begin to default on its debts. Before that there will likely be furloughs and other cost cutting measures employed to stretch the deadline out as long as possible. None of those measures are likely to be good for workers or for an already weak economy.

I don’t believe that a crisis will come to pass. I think that the moderates in the Republican party will bring the extremists to heel and that a deal will get done. I do think the Democrats will have to agree to some spending cuts to get a budget deal done. But I don’t believe that any aspect of ObamaCare will be on the table, although the inter-party fight over this legislation will likely continue for the remainder of this Presidency. Hopefully the budget will include a combination of spending cuts and tax enhancements that will make a meaningful impact on the deficit.

So what does this mean for investors? I think the market will likely close lower today, and losses could continue through the close on Monday. I think a stop-gap measure will be agreed to sometime Monday night, allowing the government to continue in business. That agreement will likely trigger a rally in the market. Therefore, I think Monday may provide a nice buying opportunity. Stay tuned.

The Cliff, The Deficit and What It Means To You

A few weeks ago (the December 8th entry) I told you that the world wasn’t coming to an end because of the Fiscal Cliff. I said that “it is HIGHLY UNLIKELY that every tax increase and spending cut will, in fact, come to pass. Some compromises will certainly be made by our leaders in Washington, despite the radical bleatings of the far right and far left. Whether the deal is brokered in the next two weeks or the next two months, I’m confident a deal will be made that will leave both sides less than happy but will stave off the worst result, which would be simply doing nothing.

As I predicted, a deal was struck with much fanfare and with thundering applause from Wall Street which rewarded the hack show by staging a huge two-day rally. That’s the good news. The bad news is that the deal accomplished virtually nothing for the long-term health of our economy. It is simply a tiny band aid on a festering wound. It feels better now but it does nothing to stop the internal bleeding.

The bigger problem is looming: the fight over the deficit and increasing the debt ceiling. And this time, the Republicans in Congress hold the power. Mr. Obama is going to have to negotiate legitimate spending cuts in Social Security, Medicare/Medicaid and other sacred cows whether he wants to or not. I don’t think there’s really any way to avoid it much longer. It’s time to take the medicine. It’s past time for America to tighten its collective belt and start living within its means. As anyone who runs a household or a business implicitly understands, you simply cannot spend more than you earn, going deeper and deeper into debt. Eventually, you either go bankrupt or someone breaks your kneecaps. I believe the national debt is now approximately $17 trillion, give or take a trillion. It’s time to start to reducing this of our own volition before our creditors force Greece-like austerity measures down the road.

But before we get to the debt ceiling drama, let’s see what the Fiscal Cliff agreement means to you and your money. First of all, if you make less than $400,000 (or $450,000 as a couple), you should be pretty happy. The only real change for you is your payroll taxes will rise 2%. The dividend and capital gains taxes remain at 15% and your income tax levels remain where they are. For those high income citizens, you will face the same 2% payroll tax increase, plus you’ll be subject to a higher tax bracket and capital gains and dividend taxes of 20%. None of this is end-of-the-world stuff. The estate tax exemption remains at $5 million which is good news for everyone. So, in the end, this really isn’t a horrible agreement; it could have been much worse. But the flip side is that while it isn’t bad for people, it’s bad for the government as it actually reduces its long-term tax receipts. Hence the looming fight over the deficit.

And what does all of this mean for our investments? The agreement on the capital gains and dividend tax rates are a plus for the stock market. The higher estate exemption is also good for the market. Any increase in payroll taxes, or income taxes, is a net negative, but it really isn’t a huge problem. So for now, we’re ok. We just need to listen to the rhetoric about the deficit and pay close attention to what kind of spending cuts are forthcoming because that will directly affect the economy, which will immediately impact the stock market. So stay tuned.