Facts About Sequestration

Have you ever heard the saying, “Out of the frying pan, into the fire?”  Basically, the phrase describes any situation where, after leaving one obstacle behind, you find yourself immediately confronted with another. 

Such a situation is exactly what the United States Congress finds itself in.  Less than two months after striking a deal to avert the fiscal cliff, Congress has a new problem to deal with … or rather, an old problem never properly dealt with in the first place.  This problem is called sequestration.  It could have a profound effect on our economy—and by extension, the markets—so as your financial advisor, I want to make sure you’re up-to-date on what’s going on. 

Sequestration

Let’s rewind back to late 2012.  Remember the fiscal cliff?  It was the combination of automatic tax increases and budget cuts that, taken together, would probably have sent the economy into another recession.  Thanks to an 11^th hour deal, Democrats and Republicans agreed to a compromise that lessened the tax increases, while simultaneously postponing the automatic budget cuts.  In effect, they patched over one problem, while punting on the second. 

Unfortunately, their punt wasn’t a very long one.  Per their agreement, the budget cuts (also known as sequestration) were to take place on March 1^st if another deal wasn’t struck. 

Now come back to the present.  March 1^st is right around the corner, and a deal isn’t looking very likely.¹  The budget cuts are a real possibility.  So what are these cuts, what will they do, and why do they have to happen in the first place? 

Let’s take the last question first.  The budget cuts are a response to an even bigger problem: the national debt.  Currently, our country’s debt is over $16 trillion dollar,² and for this year alone, we have a $0.9 trillion deficit.³  That means the government is expected to spend almost $1 trillion more than what it actually has.  These numbers simply cannot continue, but Congress has been unable to take concrete steps to lower them.  To give themselves extra incentive, Congress passed the 2011 Budget Control Act, which stipulated that if they could not lower the deficit, across-the-board spending cuts would be enacted to do it for them.

The problem with automatic, across-the-board cuts is that it’s like using a bomb when a scalpel will do.  The cuts are large, broad, and fairly sudden.  You just can’t make cuts like that without feeling negative effects.  If you compare our debt to having a drug problem, these cuts are like quitting drugs cold-turkey.  Sure, it will help your drug/debt problem … but the shock could be very painful. 

Here’s why.  The cuts for 2013 total $85.3 billion, and are divided like this:⁴

·         $42.7 billion decrease in discretionary defense funds.

·         $26.5 billion decrease in discretionary non-defense funds.

·         $11.2 billion decrease in Medicare spending.

·         $5.0 billion decrease in other areas.

These numbers are just the cuts that will take place within the next seven months.  Much larger cuts, totaling almost $1.2 trillion,⁵ will ultimately occur over the next ten years, assuming the current plan remains in place.  It would take up too much room to break down exactly what all of those cuts will do, but it’s enough to say that many jobs will be lost.  The cuts would mean government departments will have to either furlough or layoff thousands of people.  And decreased government spending means that even private companies will be affected.  For instance, if the government spends less in defense, defense contractors could have less business.  Less business means less revenue, which means fewer jobs.  In fact, the Bipartisan Policy Center estimates that as many as 1 million jobs could be lost if the sequester occurs.⁶

A few other effects:⁷

·         Unemployment benefits will go down by 9.4%.

·         The price of some types of food will go up.

·         Furloughed airport workers means there will be longer lines at airports.

Ultimately, the loss of so many jobs, combined with the belt-tightening that many Americans will have to face, means the economy could decline by 0.7% in 2013.⁶  Considering that our economy’s growth was already slow (projected to be just 2%), 0.7% is a big number.  It’s impossible to say how the markets will react, but an economic slowdown usually doesn’t mean good things.

So What Happens Next? 

That’s enough of the gory details.  Now let’s look at what could happen next.

With a few individual exceptions, neither political party wants sequestration to take place.  The problem is, neither party can agree on what the alternative should be.  Both sides profess to want to decrease our debt, but have vastly different ideas on how to do it.  Generally speaking, Republicans don’t want to cut from defense spending, and Democrats don’t want to cut from social programs.  Democrats want to increase revenue to help pay down the debt, in the form of higher taxes on the wealthy. Republicans won’t hear of the idea.

Because of all this, it’s probable that sequestration will happen.  It’s still possible the two parties could come to an agreement on how to make more targeted cuts, but it’s doubtful they can do it by March 1^st.  Instead, Congress’ best bet is to either waive the cuts altogether, or postpone them again.

If neither happens, the next thing Congress can try to do is make changes after sequestration starts but before the full effects are felt.  Unfortunately, Congress has another major problem to deal with.  They will soon run out of money to fund government operations for the rest of the 2013 fiscal year.  If they do not come up with a new funding bill by March 27, the government will shut down.⁸  If that happens, it means even more furloughs and a greater loss of government services.  On the other hand, if Congress can agree to a funding bill by that date, it’s possible they could reverse some of the automatic spending cuts at the same time.

Now the Good News

There’s no denying that Congress has become a legislative quagmire.  But there’s one thing they’re still good at: avoiding the worst.  Congress has a vested interest in ensuring the economy remains strong, and when their backs are against the wall, the most influential members of both parties have a history of abandoning their talking points in order to compromise.

One last point.  I don’t want to toot my own horn but it’s situations like this where it’s good to have a financial advisor.  Despite the complexity of the situation, remember what I always say: my team and I are constantly watching both Washington and the markets.  We’re keeping tabs on the situation, and we have a plan in place in case sequestration does happen.

I hope you found this letter to be informative.  If you have any questions about the effects of sequestration, or if you just want to discuss your investments, please don’t hesitate to give me a call.  I’d love to talk with you.  In the meantime, remember that we’re here and we’re watching out for you.  And as always, thanks for your continued trust in us.  It’s a pleasure to have clients like you.

Sincerely,

Michael L. Schwartz, RFC, CWS, CFS        

P.S.  If you have any friends or family that are confused about what’s going on in Washington, please forward this letter to them, and let them know we’d be happy to talk with them, too.

 

Sources:

¹ Andrew Taylor and Julie Pace, “John Boehner: Budget Cut Burden Lies with Democrats,” The Huffington Post, February 13, 2013.  http://www.huffingtonpost.com/2013/02/13/john-boehner-budget_n_2682656.html?utm_hp_ref=politics

²  “The Debt to the Penny and Who Holds It,” TreasuryDirect, accessed February 19, 2013.  http://www.treasurydirect.gov/NP/BPDLogin?application=np

³ “Federal Budget for FY13,” usgovernmentspending.com, accessed February 19, 2013.  http://www.usgovernmentspending.com/federal_budget_fy13

⁴ “The Sequester: Mechanics and Impact,” Bipartisan Policy Center, accessed February 21, 2013.  http://bipartisanpolicy.org/sites/default/files/Sequester%20Overview.pdf

^{5 “}Sequestration Reports,” Congressional Budget Office, accessed February 19, 2013.  http://www.cbo.gov/latest/Budget/Sequestration-Reports

⁶ Steve Bell, “Now It’s Time for Sequester Anxiety,” Bipartisan Policy Center, January 29, 2013.  http://bipartisanpolicy.org/blog/2013/01/now-it%E2%80%99s-time-sequester-anxiety

⁷ Jennifer Liberto, “7 spending cuts you’ll really feel,” CNN, February 21, 2013.  http://money.cnn.com/2013/02/21/news/economy/federal-budget-cuts/index.html

⁸ Erik Wasson, “House and Senate working quietly to avoid government shutdown,” The Hill, January 6, 2013.  http://thehill.com/blogs/on-the-money/budget/275703-house-and-senate-work-quietly-to-avoid-government-shutdown

Schwartz Financial Weekly Commentary (2/25/13)

 

The Markets

Like Canadian geese migrating in anticipation of winter, stock markets moved south last week in anticipation of monetary tightening. Minutes from the January Federal Reserve Open Market Committee meeting were released mid-week. After reviewing them, many analysts decided that quantitative easing may begin to taper off before the end of the year. Not everyone agreed with this interpretation; however, it caused major U.S. stock markets, as well as some Asian and European stock markets, to dip lower. Many markets recovered ground before Friday, but in the U.S., only the Dow Jones Industrial Index finished the week with a gain.

 

Interestingly, expectations that the Fed’s quantitative easing program may end relatively soon had little effect on Treasury bond markets. This seems counterintuitive because an end to quantitative easing (the Fed’s program of buying Treasuries to create liquidity and encourage economic improvement) could potentially lower demand for these securities and cause Treasury yields to move higher. Instead, yields moved lower last week. Experts suggested that bond investors’ apparent lack of concern may be rooted in the belief that the Federal Reserve will not ease interest rates even if it changes its policy on quantitative easing. In previous statements, the Fed has said it will not modify interest rates until unemployment rates and inflation reach specific targets.

 

Last week, The Conference Board announced that its Leading Economic Index® (LEI) for the U.S. showed America’s economy gaining some momentum. The LEI tracks 10 leading economic indicators to gauge short-term economic outlooks. The Conference Board’s LEI for China also signaled improvement. While this may prove to be good news, the impact of sequester – $85 billion in automatic spending cuts that are scheduled to begin in early March – on America’s economic growth remains unknown and highly debated.

 

Data as of 2/22/13	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	-0.3%	6.3%	11.6%	11.0%	2.3%	6.2%
10-year Treasury Note (Yield Only)	2.0	N/A	2.0	3.8	3.8	3.8
Gold (per ounce)	-2.2	-6.9	-10.0	12.2	10.8	16.1
DJ-UBS Commodity Index	-1.8	-1.7	-7.8	0.6	-8.0	0.9
DJ Equity All REIT TR Index	0.1	5.1	17.9	20.2	7.5	12.6

Notes: S&P 500, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

 

It’s important to look at more than tuition and fees when planning for college. That’s because tuition and fees account for just about 39 percent of the total budget for students who live on campus at public four-year state colleges and universities. Tuition and fees are about 20 percent of the budget for students who live off campus at public two-year state colleges and universities.

 

If that’s an unwelcome surprise, you won’t be thrilled to learn that during the 2012-2013 school year the average college budget for a student who lived on campus and attended an in-state, four-year public institution and was more than $22,000. That budget included:

 

·         Tuition and fees

·         Room and board

·         Books and supplies

·         Transportation

·         Other expenses

 

On average, the same items for a student who commuted to a two-year, in-state public college ran about $15,500. At a private non-profit, four-year college or university the average budget was more than $43,000.

 

Making college possible

So, how do students and their families afford college? The good news is that financial aid is available for many. Total financial aid for full-time students was more than $14,000 on average during the 2011-2012 academic year (the most recent data available). In addition, according to the College Board, undergraduate students received financial assistance from a variety of sources:

 

·         39 percent received federal loans and work/study

·         26 percent received Pell and other federal grant programs

·         18 percent received institutional grants

·         9 percent received federal education tax credits and deductions

·         5 percent received state grants

·         4 percent received private or employer grants

 

Is it worth it?

Scrimping and saving to pay for college often has a significant pay off. The median income for a person with a bachelor’s degree who worked full-time, year-round in 2008 was almost $56,000. That’s about $22,000 more than the median income for a high school graduate. In addition, the unemployment rate for college graduates was significantly lower than that of high school graduates during 2008 (the most recent data available).

 

Weekly Focus – Think About It

 

“Education is the ability to listen to almost anything without losing your temper or your self-confidence.”

--Robert Frost, poet

Value vs. Growth Investing (2/22/13)

Name	1-Week	YTD	4-Week	13-Week	1-Year	3-Year	5-Year
US Market	-0.36	6.83	1.81	10.19	14.13	13.81	5.21
Large Cap	-0.12	6.31	1.69	9.06	14.07	13.07	4.37
Large Core	0.08	8.11	2.86	10.92	17.92	13.87	5.73
Large Growth	-0.45	4.08	0.49	5.79	10.00	13.10	5.74
Large Value	0.05	7.05	1.89	10.85	14.73	12.33	1.48
Mid Cap	-0.99	8.16	2.05	12.89	14.16	15.59	6.77
Mid Core	-1.11	8.28	2.12	12.69	15.24	17.52	8.18
Mid Growth	-1.00	6.95	1.85	10.96	9.77	15.26	5.43
Mid Value	-0.85	9.28	2.19	15.09	17.64	13.91	6.55
Small Cap	-1.01	8.43	2.28	14.58	14.50	15.72	8.70
Small Core	-0.93	8.17	2.40	14.39	13.18	14.58	8.00
Small Growth	-0.97	7.58	1.68	13.47	12.05	16.98	8.09
Small Value	-1.12	9.52	2.70	15.82	18.45	15.63	9.92
US Core	-0.26	8.15	2.67	11.52	17.13	14.75	6.51
US Growth	-0.59	4.87	0.83	7.28	10.04	13.88	5.88
US Value	-0.22	7.66	2.01	12.03	15.54	12.88	3.07

©2004 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) is not warranted to be accurate, complete or timely. Morningstar is not responsible for any damages or losses arising from any use of this information and has not granted its consent to be considered or deemed an “expert” under the Securities Act of 1933. Past performance is no guarantee of future results.  Indices are unmanaged and while these indices can be invested in directly, this is neither a recommendation nor an offer to purchase.  This can only be done by prospectus and should be on the recommendation of a licensed professional.

 

Office Notes:

 

The Ongoing Philanthropist—

Are You Prepared to Leave a Legacy?

You box toys and shoes for disadvantaged children, collect canned goods and donate to your favorite charity every year, but have you considered leaving a permanent legacy to help support your cause?

Bequeathing money to a charity in your will is one of the best ways to act as a philanthropist through your lifetime and beyond.  Many charities rely on legacies to run their programs.  Some receive as much as 40 percent of their income from bequests.  There are many ways to leave a bequest to the charity or charities of your choice.  For example, you can donate all or part of your retirement plan, IRA, 401(k), life insurance plan, stock portfolio, or estate.

You can even ask a charity to put your money towards a specific cause or program.  For instance, those bequeathing funds to Running Strong for American Indian Youth, a nonprofit organization that helps American Indians meet their immediate survival needs and promotes self-sufficiency and self-esteem, can ask that their money support Running Strong’s community garden program or youth programs.

If you do not specify how you want your money to be used, the charity will most likely add the money to their endowment, where it can be used to support any number of worthy causes.

Many charities offer legacy programs to help potential benefactors give. Americans Helping Americans, a nonprofit that helps improve the lives of impoverished people living in Appalachia, created its Americans Helping Americans Legacy Society to recognize those who wish to include the charity in their will.

More than 80 percent of Americans give to charities.  But, a 2007 survey conducted by Indiana University’s Center on Philanthropy found that only 8 percent of all Americans include legacies in their wills.  Considering our rocky economy, that percentage has surely dropped.

Many Americans worry that by leaving a charitable bequest, they may put their heirs at a disadvantage.  But leaving a legacy in your will could reduce the estate taxes that your other beneficiaries need to pay.  Gifts given to Running Strong and Americans Helping Americans, for example, are free of federal estate taxes, as well as inheritance taxes in most states.

Charities are a wonderful way to give back to our community.  All of us want to make a difference in the world, and do something people will remember us by.  I can think of few better or easier ways than through bequeathing a legacy through your will.  If you’d like more information about how to leave a permanent legacy through charities, give me a call at 215-886-2122.

 

Regards,

,

Michael L. Schwartz, RFC®, CWS®, CFS

 

P.S.  Please feel free to forward this commentary to family, friends, or colleagues.  If you would like us to add them to the list, please reply to this email with their email address and we will ask for their permission to be added. 

 

Michael L. Schwartz, RFC®, CWS®, CFS, offers securities through First Allied Securities, Inc., A Registered Broker/Dealer,  Member FINRA-SIPC.  Advisory Services offered through First Allied Advisory Services, A Registered Investment Advisor.

Schwartz Financial Service is not an affiliate of First Allied Securities, Inc.

 

This information is provided for informational purposes only and is not a solicitation or recommendation that any particular investor should purchase or sell any security. The information contained herein is obtained from sources believed to be reliable but its accuracy or completeness is not guaranteed.  Any opinions expressed herein are subject to change without notice.  An Index is a composite of securities that provides a performance benchmark.  Returns are presented for illustrative purposes only and are not intended to project the performance of any specific investment.  Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.  Past performance is not a guarantee of future results.

 

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

 

* The DJ Global ex US is an unmanaged group of non-U.S. securities designed to reflect the performance of the global equity securities that have readily available prices. 

 

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

 

* Gold represents the London afternoon gold price fix as reported by the London Bullion Market Association.

 

* The DJ Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.

 

* The DJ Equity All REIT TR Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.

 

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.

 

* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

 

* Past performance does not guarantee future results.

 

* You cannot invest directly in an index.

 

* Consult your financial professional before making any investment decision.

 

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