I’m sure by now everyone has heard the term "fiscal cliff” and the sounds of it are enough to strike fear into the hearts of some investors and business people. Let’s try to make some simple sense of the cliff and help you decide if action may be warranted in your investment portfolio.
The fiscal cliff refers to a combination of federal spending cuts and tax increases which will take place on Jan. 1, 2013, if no action is taken by Congress between now and then. The largest impact is the expiration of the Bush tax cuts, which were enacted in 2003 and remain the same today after being extended for two years in 2010.
In 2011, Congress passed the Budget Control Act to deal with the debt ceiling crisis at the time and this act established a bipartisan commission to agree and recommend $1.2 trillion in budget cuts over the next 10 years.
They could not agree, so forced spending cuts defined in the act go into effect in the new year and coincide with the expiration of several tax laws. The result – higher taxes for many and lower government spending.
I think most would agree that lower spending is a good idea, although not to many of us want higher taxes. The bottom line is that our fiscal situation requires action of some combination of lower spending and higher revenue.
The fear at the moment is that the dramatic reduction in spending may be a retardant to economic growth in an environment where we are growing very slowly, possibly causing a new recession.
Interestingly, the financial markets have not been too panicked so far. The S&P 500 Index fell a bit in October after rising the previous four months in a row, but remains within 2 to 3 percent of recent highs.
The bond markets remain strong, particularly high yield corporate bonds, which would logically be the bonds that would suffer the most if a recession were to occur. I’ve mentioned the Index of Leading Economic Indicators before, and although not pointing to strong growth, this historically reliable indicator is not forecasting a recession, at least not yet.
Still, there is a possibility that the next few months will have a lot of strong political rhetoric causing the financial markets to be volatile until some resolution is reached, allowing individuals and businesses to make plans knowing what the ground-rules are going to be.
So, what should investors do? Well it always makes sense to review your investment plan to make sure you are in an appropriate balance of assets to try to meet your objectives for growth and income, and most importantly, controlling risk. The end of the year or the beginning of a new year is a great time to do this review.
It’s only a guess, but there is a good chance that nothing gets done until after Jan. 1, meaning that the aforementioned spending cuts and tax increases do occur, at least temporarily, until negotiations can be worked out. It is also highly likely that whatever the resulting decision on tax rates is, it will be retroactive to Jan.1.
My feeling is that we do not face a financial markets' disaster as we work through the process of dealing with this latest area of contention. But, with the potential for above average volatility and the chance I am wrong, it makes sense to err on the side of caution, especially for investors influenced by short-term market fluctuations.
Having a moderate cash reserve will buffer your portfolio against large price swings and allow you to invest at lower prices should a decline of significance occur. Owning larger, high quality companies may also provide protection against the higher volatility that smaller and more speculative stocks typically exhibit during emotional times.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.