Exactly one year ago yesterday, I penned a column with the headline “Don’t Panic: The U.S. Credit Downgrade Changes Nothing.” I got a lot of angry emails as the article went out in syndication, and commenters called me “a completely delusional ass,” among other things.
But the premise of the article proved to be quite true.
- I said it wouldn’t spur Washington to more action after the gridlock of the debt ceiling nonsense.
- I said it didn’t change the makeup of the markets significantly.
- I said it wouldn’t challenge the “safe haven” status of U.S. Treasury securities.
Disappointingly, all that has come to pass.
So where are we now? Unfortunately, in very much the same boat we were in August 2011. In fact, we might be in an even worse one.
In Washington, a Bigger ‘Fiscal Cliff’
The debt debate is reaching a fever pitch with a painful deadline looming. This time we are having a similar debate, on a much bigger scale. The so-called “Fiscal Cliff” of Jan. 1, 2013, is the ugly marriage of automatic tax increases and spending cuts that could cut an estimated $500 billion out of the economy in 2013 if Congress doesn’t act.
Click to EnlargeThe expiration of the Bush-era tax cuts across the board, for middle-class families and the wealthy alike, go off the books at the end of this year unless Democrats and Republicans can compromise. Dems refuse to allow the wealthiest to maintain their tax cuts at a time when debt levels are high and income inequality remains a hot-button issue (see the accompanying graphic from Mother Jones.) The GOP refuses to tax so-called “job creators” at the top, even though a heck of a lot of research has disproven the idea of trickling down wealth from the top. So expect fireworks and inaction on that front.
Concurrently, the debt ceiling “compromise” kicked the can down the road on actual budget decisions and sipulated across-the-board cuts of $1.2 trillion in both defense and non-defense programs starting in 2013. So in addition to agreeing on taxes, Congress has to agree on what spending to cut and what to keep.
Adding to the pressure is that without at least a temporary spending deal to keep the federal government running, we face a shutdown of the federal government for the first half of the next fiscal year — which begins in October, right before the election. The lazy and spineless politicians in Washington recessed for the rest of August, so that leaves a tight window of just a few weeks to get a deal done when they return in September.
Makes the debt ceiling look downright unimportant by contrast.
In the Markets, an Absurd Rally
Did you know the S&P 500 is up 16% in the last 12 months since the debt ceiling debacle? Did you know that many mega-stocks have outperformed even that gain, including a 66% run for Apple (NASDAQ:AAPL), a 46% run for Wal-Mart (NYSE:WMT) and a 27% run for General Electric (NYSE:GE)?
The markets are not hurting, my friends.
The irony is that unemployment continues to stay a persistent problem in America, China has showed increased signs of a slowdown, Europe is in the midst of deep recession and a debt meltdown … but stocks keep climbing higher.
So high that if the S&P 500 breaks the all-important 1,423 mark, it will have reached its highest level since spring 2008!
So much for a meltdown in capital markets after the debt-ceiling debate.
In Treasuries, Rabid Demand
Right now, interest rates are at amazingly depressed levels. The 10-year Treasury note popped to 2.59% immediately after the debt-ceiling snafu … but fell like a rock to as low as 1.38% just weeks ago! That’s almost half the levels during the “crisis.”
Why? Well, because there aren’t many alternatives. Volatility in the stock market has folks abandoning equities (despite the aforementioned rally for the S&P, I might add).
Low Federal Reserve rates have gutted CDs. Right now, the best five-year jumbo CD ($100,000 minimum) is an ugly 1.9%, according to Bankrate.com — much lower than the roughly 2.6% annual clip of inflation, and hardly a liquid option for investors who need their money. And then there’s the stuff outside the U.S., like eurozone debt. Not very attractive alternatives.
That leaves investors precious few options. Beyond U.S. Treasuries, there are basically corporate bonds — the investment-grade ones yielding little more than Treasuries, and the junk bonds carrying much more risk — and dividend stocks that also have the volatility associated with the broader markets, even if they yield 3% or so annually in distributions.
There is sticking the money under your mattress, of course. But Uncle Sam is just as safe and gives you a 1.5% return. So why not go with Treasuries?
The bitter irony of this fact is that it makes U.S. borrowing cheaper than ever before … which means our debts are less of a problem thanks to the strong demand for government bonds.
Where Do We Go From Here?
You could make the case that the only reason we haven’t had a complete meltdown of the markets in the 12 months since the debt ceiling debacle is by virtue of stalling tactics. Legislators bought time, but did not have a solution. The markets got time, too, as corporate profits continued their unmolested march upward. And Treasury bonds were bought some time thanks to the hubbub in Europe distracting the world from America’s very real fiscal crisis.
Legislators could once again fail the American people on tax cuts or spending cuts before year’s end.
The markets could run out of gas as profits stall — something that earnings are indicating is a very real risk.
And once eyes are off of Europe, they will once again notice the rather sordid state of affairs on the other side of the pond.
These are real risks. But like last year, I prefer to not play the panic card. The economy seems to be slowly mending. Even though 163,000 jobs can’t move the needle, and even though job creation is way down from the clip we saw to start 2012, each step we take away from the financial crisis of 2008 lends just a little more confidence and stability to the markets.
Election-year politicking is dangerous, but also can be quite a pressure cooker — and sometimes that’s just what Washington needs.
As for stocks, the 16% rally from last year is something many investors seemed shocked by — proving that pessimism over the state of things has prevented them from realizing the very real opportunities out there.
So don’t panic. These are hard times, but not end times. We will surely see many bumps in the road — but barring a complete breakdown in our financial or political system, America will emerge stronger in 2013.
If we do see a new depression? Well, the stock market likely will be the least of your worries.
Given the alternatives between hoping for the best and hopping in a doomsday bunker, I’d prefer to keep my money cautiously invested and keep my chin up.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.