FEW AMERICANS WOULD ARGUE that our annual federal budget deficits are unsustainable. What people do argue about is what to do about them. Last week, a bipartisan White House commission released its preliminary plan to cut the growth of the federal debt by $3.8 trillion by 2020, according to Bloomberg. And, of course, the sniping about the plan began as soon as it was released.
 
To be sure, the plan was bold. Sacred cows were skewered and, according to a co-chairman of the committee, “We have harpooned every whale in the ocean and some of the minnows.” Here are a few of the commission’s suggestions:
 

• Raise the Social Security retirement age to 69 by about 2075
• Reduce or eliminate the deduction for home-mortgage interest
• Reduce farm subsidies
• Lower and simplify individual tax rates
• Lower the corporate tax rate to 26%
• Reform medical-malpractice law
• Slow the growth of the Medicare program
• Cut the federal workforce by 10%
• Permanently ban congressional earmarks
• Cut $100 billion from military spending

The potential economic ramifications of last week’s news are, to put it mildly — huge.

Three big things happened that could have long-term effects on your portfolio and your financial well-being. First, on Tuesday, the Republicans scored a major victory in the mid-term elections and now have the upper hand in shaping the legislative agenda over the next two years. Should they succeed in cutting taxes and reducing spending, it could usher in a new era of fiscal conservatism that might cause short-term pain, but could lead to long-term gain. On the other hand, we could just end up with gridlock, finger-pointing, or compromises that please no one. 

Second, on Wednesday, the Federal Reserve cranked up the printing presses again and announced that they will buy up to $600 billion of additional Treasury securities by the end of June 2011, according to MarketWatch. In a November 4 Op-Ed piece in The Washington Post, Fed chief Ben Bernanke justified the action by saying, “Easier financial conditions will promote economic growth… lower mortgage rates will make housing more affordable and allow more homeowners to refinance… lower corporate bond rates will encourage investment… higher stock prices will boost consumer wealth and help increase confidence.” On the other hand, some critics suggest that this action will lead to high inflation, a weak dollar, and perpetuate global imbalances, according to CNBC.

Then, on Friday, the Labor Department reported that the U.S. economy created 151,000 jobs last month, which was well above the forecast of 60,000 jobs, according to Bloomberg. On top of that, the previous two months’ payrolls were revised upward to show 110,000 more jobs created than previously reported. Could the U.S. economy finally be on the cusp of a new wave of job creation?

The net result of these three sweeping things was that stock prices roared to their highest level in more than two years, according to Bloomberg. In addition, yields on two- and five-year Treasury notes dropped to record lows and gold prices surged to all-time record highs. Whew!

Barry Knapp, chief U.S. equity strategist at Barclays Plc in New York summed up the week very nicely by saying, “The elections point to the stabilization between the government and the private sector. The Fed purchases will go on for at least seven months, and the stronger-than-expected payrolls report creates an encouraging macro-environment going forward.”

Stocks surged last week with the S&P 500 up 2.1% on the week and at a 4 month high. While the week showed significant weakness midway, Friday served as an exclamation point, confirming a technical breakout.  The S&P’s surge was broad-based with consumer discretionary stocks advancing 2.9% and small caps adding 3%.

The FOMC announced that they will leave the Fed funds rate unchanged and they anticipate economic activity to require current low rates for an extended period of time. Of course, low rates and extremely low inflation will continue to produce low yields for fixed income investors. Low rates will also postpone the day of reckoning which awaits bond investors who are not prepared for inflation, higher interest rates or deflation.

Market sentiment continues to improve as productivity gains generate higher profits for big companies. This is likely to continue as corporations remain hesitant to re-hire employees who were displaced during the recession.

Market data have improved significantly this month, with last week showing technicians a strong break higher in the range-bound trading pattern of the last year. Hoxton Financial’s “Advance & Protect” investment strategy allows us to make adjustments to a client’s portfolio strategy (within the limitations set forth by the agreed investment policy) to increase or reduce exposure to various asset classes based on technical research performed by our research vendors. Our clients are aware that earlier this year we reduced exposure to stocks, particularly Emerging Markets, US Large Cap Growth and Small Caps. With positive market momentum confirmed this month and particularly last week, we will begin to reintroduce these equity asset classes.

HOW THE RICH SPEND THEIR MONEY may have a big impact on the pace of our economic recovery. Consider this, the top 5% of Americans by income account for 37% of all consumer outlays, according to an August 5 Wall Street Journal article that was based on data from Moody’s Analytics. At the other end of the spectrum, the bottom 80% by income account for 39.5% of all consumer outlays. So much for the 80/20 rule!

The share of spending by the top 5% has grown over the years, too. Back in the third quarter of 1990, the top 5% accounted for 25% of consumer outlays versus the 37% today, according to the Journal article.

In a 2005 research report, analysts at Citigroup coined the phrase “Plutonomy” to describe countries that exhibit significant income and wealth inequality. Plutonomies also are disproportionately dependent on the spending habits of the wealthy. According to that 2005 report, Citigroup classified the U.S., U.K., Canada, and Australia as Plutonomies.

So, if you want to know where the economy is heading—follow the money!

Last week was a positive week for the markets, celebrating with a 140 point rally early Friday on better than expected employment figures. Interestingly, by the end of the day massive selling took the gains away as if to suggest that market participants don’t believe the numbers. I don’t beleive them either.

Meanwhile, the Obama administration pitched that this was the best report since 2007. Don’t get me wrong, any good news on employment is great with me. I’m just not confident that the whole story is being told. I have read estimates that put real unemployment rates at 21 percent. Of course these estimates include workers who are underemployed or have just given up looking for a job.

If I lost my job as an investment advisor and took a job as a sales clerk in a retail shop, I would be underemployed and would want to be counted in the report.

Could We Learn a Lesson from Wiley?

Remember when Wiley Coyotte would chase  Roadrunner off the edge of a cliff? There was always that awkward passage of time as he sheepishly tip-toed back to the edge only to plunge to the valley below. Recently, I have heard our economy’s current state described using this cartoon from our childhood. Why is it that Wiley never has a parachute?

It is likely that our economy will experience a double dip recession and investment portfolios should recognize this potential. As we enjoy this record recovery in securities prices, one cannot help but think what will happen if the economy slips into recession again. Now is the time to have your strategy in place.

Meredith Whitney, the bank analyst who predicted last year’s collapse of the credit markets was quoted in the financial press today as being more bearish now than at any point in the last year. I agree.

That being said, we’ll enjoy this bear market rally while it lasts; always with an eye for the door though.