As 2012 fades into the memory banks, the financial markets of 2013 are beginning the year in a very similar fashion to last year. Despite estimates for the U.S. economy to grow at a tepid 2% pace, along with a deepening European recession, stock markets around the world are off to a very optimistic start in the new year.
These strong markets are being driven by the “developed world’s” central banks unending policy of money creation. Essentially, the USA, UK, Switzerland, Europe and Japan are attempting to inflate their economies out of their economic malaise. Domestically, Ben Bernanke and the U.S. Federal Reserve Bank are printing $85 billion every month and then purchasing that same amount of U.S. Government and Government Agency bonds. This ongoing effort of financial market manipulation, to keep interest rates low, encourages investment capital to move out of the safety of money markets, treasury bills and C.D.’s and into the riskier investments of stocks and real estate. Unfortunately, the central bank’s bond-buying-strategy cannot continue indefinitely and must end at some point. Like an addiction, the longer the market manipulation, the more reliant the financial markets become on it and the more vulnerable these markets are to future volatility. We do not expect the Federal Reserve Bank to change their levels of bond purchases any time soon, but as the “when to reduce and/or stop the policy” debate continues, the markets are likely to become increasingly nervous. Until our U.S. Congress and President come to a long-term resolution on the budget deficit, the markets will move in fits and starts.
In recent months, we have been shifting more investments into inflation sensitive securities, while reducing our bond holdings. Pacific Wealth Management believes these extraordinary times continue to make prudent diversification an essential part of our wealth preservation strategy.
The long awaited elections are now behind us and, as we expected, nothing has changed in Washington D.C. An equally divided American electorate has chosen to maintain the political status quo. Our government leaders, unfortunately, do not inspire confidence and last week’s “post-election” stock market decline underscored the financial market nervousness regarding our economic prospects, while hinting at more volatility over the next few months.
Pacific Wealth Management has maintained a conservative posture to our portfolios throughout the year. European Union challenges, the presidential election and a muddy tax outlook increased risk levels across most financial markets. The global media is now obsessing over the looming year-end “Fiscal Cliff” issues awaiting the world’s largest economy. If the U.S. Congress and President Obama do not compromise, the expiration of the Bush tax cuts will dramatically increase taxes and impose draconian across-the-board spending cuts and send the tepidly-growing American economy into another deep recession. We do believe the politicians will come to a last minute resolution, but likely play the same game of chicken we painfully watched in the summer of 2011 with the last “debt ceiling” debate. President Obama has a little more incentive to compromise, secure his legacy and avoid lame-duck status by breaking the gridlock in Washington. Unfortunately, we feel the most probable outcome will be another Band-Aid solution that defers the politically challenging, but much needed long term deficit reduction solution, to another day or even future year. This political drama and resulting financial market volatility are presenting opportunities for us to further diversify into investments offering competitive long term inflation protection.
As the global economy continues to slow, we expect interest rates will stay low in the foreseeable future. The increase we expect in taxes is likely to diminish the economy’s ability to grow and overall investment return expectations have diminished. We continue managing investment risk with a focus on wealth preservation.
We wish you and your family a warm and enjoyable Thanksgiving holiday and an appreciation for our many gifts.