As the third quarter came to a close, eyes were on Washington as the House of Representatives escalated what has been an annual brawl over the budget into a shutdown of mostly non-essential functions of the Federal Government. Congress has been rehearsing for this Kabuki dance since the last government shutdown in the mid ’90’s. They have made sure to insulate themselves from the most powerful constituencies by exempting Social Security, Medicare, Federal Aviation Administration and National Security related entities from the “shut down.” This keeps most voters from flooding Congress with hate mail for a while, unless they happen to have planned a national park vacation. If predictions that the stand off will continue for weeks is correct, then the buffalo in Yellowstone will be free to roam without those annoying cameras clicking, at least for a while.

Should you be worried? Bullish equity markets are said to “climb a wall of worry.”  The media can be reliably counted upon to magnify the crisis du jour, but economic fundamentals trumps temporary crisis in the long-term. I believe there is a good chance that the shutdown and the debt ceiling debate to come will cause a market sell-off. Since Trusted Financial Advisors invests based on long term fundamentals, a healthy sell off will likely be an opportunity to pick up some good merchandise for client portfolios.

The positive fundamentals driving the US equity market at this time are:

 

  • near record low borrowing costs for businesses
  • improved consumer confidence
  • falling jobless rates
  • recovery in the housing and construction sector
  • an era of flat to lower energy costs

Now consider the things that are not so bad at this time:

  • we are not in a shooting war in the Middle East
  • we are not on the verge of a new higher tax rate (as during the last quarter of 2012)
  • we are not facing the uncertainty of an election
  • we are not facing a massive clean up bill from a major hurricane, earthquake or similar natural disaster.

…and for those over age 45, recall that we are not on the verge of a nuclear war, something that  frequently seemed imminent between 1949 when the Russians got the Bomb and about 1991 when the Soviet Union collapsed.

One of the most attractive aspects of investing in equities today is the relatively high earnings yield, reflecting the level of dividends and interest still available to savvy investors. Certain utility companies are paying between 3% and 6.5%; preferred stocks are available with dividends over 6%.

These yields represent something like 3 to 5 times that available from certificates of deposit. Of course savvy investors also know that earning higher returns entails more risk than owning certificates of deposit. The past five months have adequately demonstrated this principal. When the Federal Reserve Chairman ruminated aloud about “tapering” the extraordinary bond buying program that has kept interest rates so low, back in May many high yielding holdings dropped sharply in market price. This irrational behavior has, admittedly, dampened our clients’ performance, but most prefer the comfort of regular income at competitive yields to “safety” of government guaranteed instruments, whose yields today barely cover the damage caused by inflation. Year-to-date client portfolio returns have varied widely, but if I had to name a median return it would be a positive 6%. This return is decidedly lower than the stock market averages so far in 2013, but we have always postulated that our managed portfolios would seem to “underperform” during bull markets. We earned client loyalty by outperforming during the last two stock market crashes, the 2002 Tech Wreck and the 2008 Financial Meltdown. When your losses are controlled, it does not require a money manager to “outperform” during the recovery that follows. Over market bull-and-bear cycles, I believe we provide competitive total returns along with regular cash flow to our clients.