Funding Fault: Recurring US Debt Dilemma Takes Toll

Funding Fault: Recurring US Debt Dilemma Takes Toll

Part 3: Keep Calm and Carry On

This third post of the three-part series about the ongoing US debt ceiling debate offers strategies to help investors position themselves for the next debt showdown in January 2014. Part 1 examined circumstances surrounding the latest deadlock last September, while Part 2 discussed the relatively minimal reaction to the debt dilemma in the markets.

How should investors prepare as the debt debate encore plays out in early 2014?  Just as a British World War II poster advises:  “Keep calm and carry on.” These four snapshots of broader long-term market and economic trends provide useful context for dispassionate evaluation of shorter-term current events.

1. Economy: A loaded freight train

Over the 12-month period ending Sept. 30, 2013, the US economy produced $16.9 trillion in goods and services, 3.1% higher than a year earlier in nominal terms.1 Challenges notwithstanding, the economy is like a loaded freight train — unlikely to set speed records, but moving at a steady pace with massive momentum behind it.

A positive sign is that the government’s share of the economy as a percentage of gross domestic product has decreased— from approximately 25% in 2010 and 2011 to roughly 23% currently2 — which means the private sector’s contribution is increasing.

2. The Fed: A new head

On Jan. 31, 2014, Janet Yellen will replace Ben Bernanke as chairman of the Board of Governors of the Federal Reserve (Fed). She is viewed as an inflation dove who will likely support continued monetary accommodation if forced to choose between addressing inflation or lingering unemployment.

The Fed’s ongoing policy of asset purchases, known as quantitative easing (QE), has boosted its balance sheet to nearly $4 trillion, an increase of more than 300% since it initiated QE in 2008.3 Additionally, the Fed will continue its policy of keeping its short-term interest rate near zero as long as the unemployment rate remains above 6.5%. All else equal, accommodative Fed policy stimulates the economy and is generally supportive of stocks.

3. Equity market: New highs

A growing private sector should generally be positive for the stock market. As the chart below shows, the S&P 500 Index was up 28% year to date through the middle of November as it continued to reach new highs that have underlying fundamental support.

New Highs for the S&P 500 Index Supported by Fundamentals

Source: Bloomberg L.P., Nov. 18, 2013

With both the stock market and Fed balance sheet at all-time highs, what should investors expect if the Fed begins tapering?

  • Keep in mind that tapering is more like lifting a foot off the gas than slamming on the breaks.  A car that slows from 85 to 75 miles per hour is still moving fast.
  • Probably more important, the banking system has used the money from Fed asset purchases to build excess reserves rather than lending it. If this additional money isn’t flowing into the stock market or economy, slowing the flow with tapering may have little discernible impact on the stock market.

4. Inflation: Likely to remain low

Despite significant growth in the monetary base, inflation and inflation expectations remain in check. For the 12 months ended Oct. 31, 2013, the Consumer Price Index was up just 1.2%, with five-year inflation expectations at 1.8%.4 The unwillingness of banks to release their excess reserves into the economy via additional lending is contributing to these low levels. With bank lending only just recently recovering to its 2008 peak, in an economy that’s 16% larger,5 any upward pressure on the velocity of money — and by extension, inflation — will likely remain low.

Stay the course

Early 2014 may take us back to the future. While investors shouldn’t turn a blind eye to challenges facing the economy and markets, looking at the broader picture can help them stay the course and keep moving forward with their financial goals.

 

1 Source: Bloomberg L.P., Sept. 30, 2013

2 Source: Federal Reserve Bank of St. Louis, Sept. 30, 2013

3 Source: Bloomberg L.P., Nov. 18, 2013

4 Source: Bloomberg L.P., Oct. 31, 2013

5 Source: Bloomberg L.P., Federal Reserve Bank of St. Louis, Oct. 31, 2013

The S&P 500® Index is an unmanaged index considered representative of the US stock market. An investment cannot be made directly in an index.

Joseph Becker

Sr. Fixed & Equity Income Product Strategist

Invesco PowerShares Capital Management LLC

Joseph Becker is the Sr. Fixed & Equity Income Product Strategist with Invesco PowerShares Capital Management LLC, a registered investment advisor that sponsors the PowerShares family of exchange-traded funds (ETFs). Invesco PowerShares is Leading the Intelligent ETF Revolution®, a new generation of ETFs.

In his role as Sr. Fixed & Equity Income Product Strategist, Joseph develops and manages product specific strategies, collaborating with marketing, compliance, research, sales and portfolio management in an effort to better position the product line within the market.

Prior to joining Product Strategy & Research in 2010, Joseph served as the manager of education marketing for Invesco PowerShares. In that role, he was responsible for the creation of educational content for both institutional and retail investors. Joseph has been with Invesco PowerShares since 2008 and brings more than a decade of investment industry experience to his role.

Joseph holds a Master’s Degree in Economics from The University of Illinois at Chicago and a Bachelor’s Degree in International Studies from Trinity Western University in British Columbia, Canada. He holds the Series 7, 4 and 63 registrations.

Invesco Distributors, Inc. is the distributor of the PowerShares Exchange-Traded Fund Trust, the PowerShares Exchange-Traded Fund Trust II, the PowerShares India Exchange-Traded Fund Trust and the PowerShares Actively Managed Exchange-Traded Fund Trust. Invesco PowerShares Capital Management LLC (Invesco PowerShares) and Invesco Distributors, Inc. are indirect, wholly owned subsidiaries of Invesco Ltd.

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