Drama or Comedy

3Q 2013

I think we’ve seen this play before. It is at the same time partially fictitious and partly self-fulfilling. If we didn’t know the 3rd Quarter results, we’d likely feel that the political drama was crushing the economy and markets. It hasn’t and this is not inconsistent with the prior 17 times the government “shut down” or experienced “funding gaps” since 1976. The most recent, and longest of those started December 15, 1995 and ended on January 6, 1996. In that season, the stock market returned 2.7% in the four weeks leading up to the shut down and another 3.1% return in the four weeks following. In addition, the subsequent four years were not impacted negatively and helped complete the single best 5-year stretch for US markets of the century (1995-1999). A quick list of quarterly and year-to-date returns on several broad asset classes was as follows:

Benchmark                                                     3Q                YTD

S&P 500 Index ( Core US Stocks)                   5.2%             19.8%

Russell 2000 Index ( Small Stocks)               10.2%            27.7%

MSCI EAFE Index ( International Stocks)     11.6%            16.7%

MSCI Emrg Mkts Index ( Em Mkt Stocks)        5.9%        – 4.1%

FTSE/EPRA NAREIT Index ( Real Estate)    2.1%              3.4%

BC Agg. Index ( Core US Bonds)                      0.6%          – 1.9%

30 Day US Treasury Bills ( Cash)                      0.0%           0.0%

In our opinion, these results are because of the shut downs, nor in spite of them. They are, we believe, a proof point that the connection between government activity and corporate earnings/prices is not as “if/ then” as many might calculate. This seems an appropriate time to be re-reminded that “past performance is no guarantee of future results.” We’re in no way forecasting that good results come from government shut-downs. We’re only seeking to demonstrate that they may not be as perfectly correlated as they feel.

Three quick definitions are relevant in reviewing the third quarter and launching the fourth.

Budget Resolution Expiration: Government spending authority on “non-essential” items with certain exceptions like interest on Treasury securities, entitlement programs, certain defense items, etc. ended on 9/30/13 (temporarily). Uncertainty around this in the last week of September put a lot of emotional pressure on the “better than average quarter” shown above.

Federal Debt Ceiling: The US is expected to hit its maximum debt ceiling of nearly $17 Trillion sometime in mid-October. At that point, ALL Federal spending could come to a halt unless Congress increases the Government’s ability to borrow money.

Drama: Described on thefreedictionary.com as: a work to be performed by actors on stage, radio, or television…a situation or sequence of events that is highly emotional, tragic, or turbulent.

To quote Karthik Ramanathan, senior vice president and director of bonds for Fidelity Investments New York, this may be the “storm before the calm.” Mr. Ramanathan’s view as expressed in the September 30th edition of Pensions & Investments magazine jibes with our own opinion that in essence, Congress will again raise the debt ceiling as they always have. It has now been raised or “re-defined” 78 times since 1960. Each experience in hitting that ceiling is like watching the same TV drama with only a few of the actors changing and no change to the script. Boring. Predictable. Frustrating. It reminds us of the Mark Twain quote “I am an old man and have known a great many troubles, but most of them never happened.”

So, back to the returns table above. It was a very good quarter for equities and even provided a little bounce back in the fixed income (bond) markets. While the year has been very tough on the Emerging Markets asset class, the 3rd quarter result was impressive. It may be that the tension around government shutdowns has taken some of the focus off of the pressure third world markets were experiencing as a potential war with Syria was being debated.

We would never try to make a career out of timing the markets, interest rates or wars for that matter. On the contrary, we will always seek to make hay when any long-term asset class/market moves up or down dramatically. This is accomplished through two basic and repeatable disciplines: rebalancing and where applicable, tax loss harvesting. These activities take the unproductive and harmful geopolitical challenges and converts them into opportunities to improve long-term portfolios. We hope you agree.