Polishing the Crystal Ball: Looking Ahead to Q4 and 2013
Cooling temperatures as we move from summer to fall, children returning to school, the winding down of baseball season and the ramp-up of football: These are a few of the traditional milestones that accompany the end of the third quarter each year. It’s also time for another seemingly annual event—the prediction of which tax laws and stopgap legislation will be enacted in the closing months of the year.
Lawmakers today appear to be unable or unwilling to work together toward long-term solutions and instead focus their efforts on temporary “fixes.” This has ushered in an era of uncertainty, making it increasingly difficult for businesses and taxpayers to make long-term plans of their own with confidence, and it has contributed to the slower economic recovery both here in the United States and abroad.
Despite the challenging business environment, the equity markets have performed relatively well in 2012 and in the third quarter in particular. (See chart.) Corporate profitability has remained strong, the urgency of the European debt crisis has subsided (at least for the time being), and the Federal Reserve has continued its attempts to keep interest rates anchored near all-time lows.
All these factors have contributed to positive returns for the markets but unfortunately haven’t created sustained growth in the underlying economy. Despite the early-October data reporting that the US unemployment rate has hit a four-year low, jobs still aren’t being created at a brisk enough pace to truly make an impact. This has prompted the Fed to take action.
Quantitative Easing, Take Three
Driven by its dual mandate of keeping inflation in check and maximizing employment, the Fed launched a new round of quantitative easing in September. The goal in this latest program, much as it was in previous attempts, is to encourage lending and borrowing for home mortgages as well as capital investment by businesses.
One important distinction about QE3, though, is that the Fed has declared it will continue to purchase around $40 billion of mortgage-backed securities each month until it gets the results it’s seeking—an improved labor market. This program may be successful in at least temporarily propping up housing prices and encouraging the desired trickle-down increase in consumer spending that goes along with appreciating home prices. However, this boost is likely to be temporary, and without real economic growth the labor market will continue to be sluggish.
Six Areas to Watch
As we move into the fourth quarter and 2013, there are a number of things to monitor that could affect our economy, the direction of tax rates, and ultimately your portfolio.
Resolution of the “Fiscal Cliff”
With Congress having already left early for recess, it looks as if this issue will become the responsibility of the lame-duck Congress after the elections and the newly seated Congress in early 2013. It appears quite possible that we’ll retain a split Congress in November and that compromise on the issue will continue to be elusive. This could result in a resurfacing of the US credit rating issue as well as increased volatility in the global equity markets. With such a wide range of potential outcomes, maintaining a diversified risk profile in your portfolio remains crucial.
European Sovereign Debt
We’re in a period of relative calm thanks to the apparent willingness by Germany and other countries to provide financial support to Greece, Italy, Spain, and others as needed. That support will come with conditions, however, and it remains to be seen whether current and future leadership in those troubled nations will be willing to make the sacrifices required of them.
Responsible reforms could lead to improved stability in Europe and longer-term economic growth. A failure to implement economic reform would increase the cost of capital as investors demand higher yields on the ailing nations’ bonds, potentially causing their already fragile economies to slip back into recession. Europe remains a crucial part of the global economy, and countries like China rely heavily on their exports to Europe to grow their economy.
Tensions in the Middle East
Aside from the obvious human cost and disruption to the oil markets, turmoil in this region also tends to be expensive, especially if the United States ends up getting militarily involved. In a time when Congress is looking for ways to cut spending, this is the type of issue that could hamper those efforts, not to mention complicate negotiations over cuts to the defense budget that could come into play as Congress approaches the fiscal cliff.
Inflation and Interest Rates
The Fed announced its intent to keep interest rates low through mid-2015. So far this hasn’t resulted in rising inflation other than some recent volatility in food and fuel prices. However, it has been challenging for savers to find returns on cash—a situation likely to persist in 2013.
As a result, you should review your annual cash needs and make sure you have adequate reserves to meet your upcoming living expenses and fund an emergency reserve. Cash holdings in excess of these items should be reviewed to determine whether alternative fixed income allocations might enhance yield and still maintain an acceptable risk profile in your portfolio.
Health Care Reform
More of the provisions of the Affordable Care Act will begin to take shape in 2013 and 2014. We’ll continue to see the health care and health insurance industries go through changes as they prepare for new reimbursement and coverage requirements. The impact of these changes will vary widely based on each individual’s situation. You should review the likelihood of increased costs and changes to your insurance coverage and update your financial planning assumptions to take these into account.
Make sure to take care of the fundamentals. Now is a good opportunity to do year-end tax planning, capital gain or loss harvesting, IRA distribution planning, and general portfolio rebalancing as necessary so you’re positioned well as some of these other items unfold.
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It can be easy to become distracted by all the uncertainty, but it’s important to stay focused on the things you can control—staying on track for retirement, saving for college expenses, growing your business, and other goals. For help with all this and more, contact your Moss Adams wealth advisor.
Past performance is not a guarantee of future results. Index performance does not reflect the expenses associated with the management of an actual portfolio. Market segment (index representation) as follows: US Stock Market (Russell 3000 Index); International Developed Stocks (MSCI World ex USA Index [net div.]), Emerging Markets (MSCI Emerging Markets Index [net div.]), Global Real Estate (S&P Global REIT Index), US Bond Market (Barclays Capital US Aggregate Bond Index), and Global Bond Market (Barclays Capital Global Aggregate Bond Index [Hedged to USD]). The S&P data are provided by Standard & Poor’s Index Services Group. Russell data copyright © Russell Investment Group 1995–2012, all rights reserved. MSCI data copyright MSCI 2012, all rights reserved. Barclays Capital data provided by Barclays Bank PLC. US long-term bonds, bills, and inflation data © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).
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