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One Cliff Down, Two More to Go

On New Year’s Day, in an emergency session, congress came to an agreement to avert the fiscal cliff.  However, the only issue that was addressed was the impending reversion to 1990’s era tax rates.  It was agreed that those earning over $400K would see tax increases, but those earning less than that would not see their tax rates rise.  The other half of the fiscal cliff, the $110 billion in spending cuts to government agencies, was kicked down the road two months.  Both sides are already posturing over this next battle.  Thus, the political theater driven volatility that has dominated the past two months will ramp up as this new deadline draws closer. 

In addition, the federal debt ceiling is expected to reach its limit by March unless an agreement is reached to raise it.  This brings us back to the summer of 2011 when political wrangling over the debt ceiling roiled markets and resulted in the U.S. losing its triple A debt rating by Standard & Poor’s.  Fellow rating agency Moody’s has already commented that it may downgrade the U.S. pending the result of this next political fight.

Investors have been through this debt ceiling fight before.  Pundits expected stocks and bonds to plunge after the downgrade in credit rating that resulted from congress’ indecision.  However, investors still viewed Treasurys as one of the safest investments and they gained 7.4% to end 2011.  Stocks did fall after the downgrade, but they rebounded to pre-downgrade levels in three months.

A similar scenario could play out this time around. With the rancorous back and forth debate it’s important for investors to remember to not panic and think about the goals of their investment portfolios.  Fixed income is designed to dampen volatility while stocks provide the potential for long term growth.  There is likely to be much volatility over the next few months with markets reacting to the latest developments in Washington, but we firmly believe that investors who can look past the month’s current challenge and focus on the longer term will see their portfolio prosper.

Index Performance                                    Dec.     QTD        YTD

US Stock (Russell 3000)                                 1.23%    0.25%     16.42%        
Foreign Stock (FTSE AW ex US)                   3.62%    6.10%     17.80%        
Total US Bond Mkt. (BarCap Aggregate)    -0.14%    0.22%      4.22%         
Short US Gov. Bonds (BarCap Gov 1-5 Yr) -0.04%   0.06%      0.97%
Municipal Bonds (BarCap 1-10yr Muni)      -0.77%    0.30%      3.56%
Cash (ML 3Month T-Bill)                              0.02%    0.04%       0.11%