Your Investments: Sequestration and your portfolio

Remember back a few months when everyone was talking about the “fiscal cliff” and what a big crisis it was supposed to be, bringing Armageddon to financial markets?

Well that “crisis” ended with a whimper, just like most overly hyped crises. Did your computer explode on January 1, 2000? Well we have another supposed crisis that’s going to wreak havoc with the global economy, drag the US into another recession, add millions to the unemployment rolls, etc. Unless an agreement is reached, in another week we will have the “sequestration” hit.

What is sequestration? One definition is the action of taking forcible possession of something; i.e., confiscation. Sort of what the government does to us routinely, but that’s for another column. When dealing with the federal budget it is a term that means mandatory spending cuts will take place if the government spends too much without authorization.

How does it work?

The sequester is a rash of spending cuts scheduled to hit on March 1. Unless Congress acts, $85 billion in across-the-board cuts will occur this year, with another $1.1 trillion coming over the next decade. Sounds like a lot, until you realize that: 1) you are talking about a budget of $4t.; and 2) as I have written in a previous column, these aren’t even cuts; it just a smaller increase in the budget that was originally planned (hardly what normal people consider a cut).

Now all the hysteria has started. I don’t mean political posturing from the likes of President Obama, who created this in 2011, telling anyone who will listen that these cuts are going to leave hundreds of thousands of mentally ill people without treatment, end day care, border agents will see reduced hours, criminals will be set free – you get the point.

But journalists are also more than nervous about the impact of the cuts. Writing in MarketWatch, John Nyaradi says: “Federal spending will be slashed by $85 billion between now and September 30 when our government’s fiscal year ends. From October 1 of this year until September 30, 2021, there will be annual cuts of $109b. The $85b. in cuts to this year’s budget will kick in during the second and third quarters of the calendar year, bringing great havoc over the remaining months of 2013. Examples of some of the cuts include 5 percent less funding for Hurricane Sandy relief efforts, displacing many of those whose homes were destroyed by the storm, the loss of over one million jobs during 2013 and 2014, and significant impacts to military and defense spending.”

“For investors, the outlook is equally troublesome,” he adds. “Already, the elimination of the payroll tax holiday is forecast to reduce GDP by 1.5% in 2013. The sequester is expected to take away another percentage point of GDP growth. With a 2.5% loss in GDP growth, we may very well find ourselves in another recession.”

Reality check

Let’s try and leave our political emotions at the door and look at things rationally. The $85b. is a little more than 2% of the budget. You mean to tell me that there is no waste at all in the US federal budget? Give me a break. Do some basic math and you’ll see that it’s like trying to find $85 to save from a $4,000 budget.

I do a lot of volunteering for an organization that works with families in debt, and we help give them the tools to get out of debt and live within their means. In almost every case you can manage to save such a small amount. Families can do it by slightly limiting their heat or air-conditioning use, plus some smarter shopping decisions, and it doesn’t even impact their lives.

Hard to fathom that the government can’t do without 2% of their budget.

Your investments

Many pundits are saying this will be a disaster for stocks. They are encouraging investors to move to cash because if the automatic cuts go into effect, markets will tumble, being that they haven’t been factoring in this possibility. My response would be that in general this will be a meaningless event for the economy as a whole. As for individual investors, each one is different and should take a different approach into preparing their portfolios for next week.

If you are a retiree who needs to be very careful with limited retirement funds, it may pay to move some money into cash because it’s of utmost importance not to lose money, as opposed to making another percent or two.

Speak with your financial adviser to see if you are prepared for the upcoming sequestration.

aaron@lighthousecapital.co.il
Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.