Here we go again. Our beloved elected officials posture as a budget impasse looms. While the market seems to be taking the latest noise from Washington in stride, that could change.
It's important to recognize that the contentious discussions highlight a greater problem for the U.S. economy: a massive federal deficit that currently counts in the trillions of dollars.
To be sure, as economic growth continues to stumble forward, the budget deficit will decrease in size simply because of higher tax revenues. But remember, this potential reduction comes on the backs of millions of investors that currently earn nothing in money market accounts and certificates of deposits. Just imagine those living on a fixed income alone and you can see the massive negative impact of our current fiscal woes.
Interest rates are low because economic activity requires that they be at attractive levels to spur economic activity. While mortgage holders celebrate, those that rely on interest instruments do not share in that joy. This really is indicative of a greater long-term challenge facing the U.S. economy and underscores why we are conservative as we invest: there doesn't appear to be a set path to solve the nation's budget woes.
We think it's unlikely that there will be any meaningful deficit reduction efforts or any significant tax increases; the status quo will likely remain in place. Just think about the sequestration drama and how contentious that debate was. The amount of sequestration cuts – $85.4 billion in spending cuts for 2013 with similar cuts through 2021 – was a drop in the bucket relative to the overall U.S. deficit.
We continue to believe that the budget deficit will be attacked by inflating the debt ceiling, something that has happened before. Inflating the debt ceiling means letting inflation run to increase tax revenues. The cost of cars, food and other items rise thereby increasing tax revenues. While this may sound rosy, the truth is it will have negative consequences on the standard of living in the U.S.
This is not to say that we're headed towards an economic collapse; I don't believe that's the case. However, I do believe the standard of living in the U.S. will be under pressure as a result of inaction in Washington and the easy path to inflate the deficit.
What does this mean from an investment standpoint?
1) It makes sense to have companies that have strong cash flow, pay dividends, and possess solid balance in your portfolio.
2) A sprinkling of emerging market assets (not an over-concentration) is a good way to capture higher growth rates in other countries (a long-term strategy to be sure).
3) Because of impending inflation, fixed durations should remain fairly low until interest rates rise. Until emerging market growth restarts, commodities will likely be negatively affected by slower global growth rates.
Portfolios need to be invested in a way that assumes that slower growth is on the horizon as Washington is clearly moving along a path of stagnation.
—Michael Yoshikami is the CEO and founder of the investment committee of Destination Wealth Management.