Investment Responses to Debt Resolution Plan

Analysts maintain that market volatility is still likely despite the passage of a debt resolution plan, and that much damage has already been done in terms of investor …

Analysts maintain that market volatility is still likely despite the passage of a debt resolution plan, and that much damage has already been done in terms of investor confidence and ratings agency responses to the plan. There is a good chance the U.S. credit rating may still be downgraded, which could lower the value of Treasury bonds and put them out of range of investment per regulations of many funds. This could impact the housing market by raising interest rates and lowering prices. Financial experts recommend investors be wary of housing and stock market volatility, and to continue investing in retirement and pension plans while the dust settles. For more on this continue reading the following article from The Street.

It isn’t over yet.

Even with a resolution to the debt ceiling impasse in Washington, the hangover of lingering economic woes here and abroad will continue to affect all of us.

What does it all mean for the average consumer or investor, and what moves should they make, or avoid, given continued uncertainty?

Real estate ripples

Those looking to take advantage of the drop in housing prices may find they would do best to ride out the debt crisis for a bit longer.

Even with a resolution to the debt ceiling debate, the nation’s debt crisis could still lead to a downgrade in its creditworthiness that will potentially make getting a loan more expensive in the weeks ahead.

"Bonds issued by Fannie Mae and Freddie Mac will probably lose their AAA status if the U.S. credit rating is downgraded," says Gibran Nicholas, chairman of the CMPS Institute, an organization that trains and certifies mortgage bankers and brokers. "This means that mortgage rates will likely go up."

The monthly payment on a $200,000, 30-year mortgage would increase by $240 per month if mortgage rates go up slightly to 6.43% from 4.51%, as they were just three short years ago, he says. Even if interest rates go up by 1% it would cost an extra $122 per month.

Nicholas adds that those who have an adjustable interest rate tied to LIBOR or U.S. Treasuries will likely find that their mortgage rate will fluctuate as banks, investors and money market funds figure out what to do with the temporary loss of a AAA credit rating for U.S. Treasuries.

"Many investment funds are only allowed to invest in AAA-rated investments," he says. "This means they will have to either change their bylaws in order to keep their U.S. Treasurys and mortgage bonds or sell their Treasurys and mortgage-backed securities. This will cause Treasury and mortgage bond yields to fluctuate considerably over the next few months, adding even more uncertainty to an already fragile mortgage and housing market."

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"The U.S. debt burden is growing by about $1.5 trillion per year and our elected officials seem to be so incompetent that they are jeopardizing even the $15 trillion in economic activity that we do have as a nation," Nicholas says. "We are acting like we are mentally unstable, with no long-term plan for improving our financial situation. The bottom line is that we don’t have a ‘debt crisis,’ we have a ‘credibility crisis.’ There will be some temporary negative consequences because of all this, even if the debt ceiling is increased at the last minute."

Keep your eye on the ball

A survey released last week of TD Ameritrade(AMTD) clients found that 72% of retail investors are "extremely dissatisfied" with Congress’ management of the debt ceiling issue.

Nearly half (48%) called the debt ceiling debate "very" or "extremely" influential on their decision to engage in the markets.

"Policy uncertainties make markets jittery, but these kinds of macro-economic uncertainties are out of retail investors’ control," says Lule Demmissie, managing director of retirement at TD Ameritrade. "This is an opportunity for retail investors to evaluate their investment portfolios and make sure they are diversified in line with their current risk tolerance and investment objectives."

"Stay focused on long-term investment strategies and avoid short-term reactions that are motivated purely by fear," he adds.

Keep saving, invest wisely

Eric H. Zoldan, senior vice president of investments at JHS Capital Advisors in New York, fears the focus on the debt ceiling debate may have diverted attention from the broader economic dangers that exist globally.

Even once the debt ceiling is resolved, the U.S. faces a staggering debt and spending problem, as well as uncertainty over taxes and regulatory efforts. And all this comes amid the backdrop of the European debt crisis.

"The government debt problem is a universal problem around the world," he says. "The debt ceiling is kind of the symptom; the real problem is the underlying fundamentals of the economy."

Zoldan points out that in many of the recent conference calls that accompanied earnings reports, numerous CEOs and CFOs said they are not making business moves due to Washington’s uncertainty.

While some of that talk may be setting the stage to pass the blame for weak results, "it certainly sends a message too that businesses are sitting on an awful lot of cash, that cash isn’t being used to hire people or to expand because of the uncertainty of political policy." he says. "Its not just the debt, it is regulatory issues, tax issues and on and on and on. Our concern is that we have a political, Washington drag that could go on for well past Tuesday and the debt ceiling being raised."

Amid the uncertainty, Zoldan still says that people should continue to save and "absolutely keep putting money into" 401(k)s and IRAs.

"Having a capital base always creates options, it creates flexibility," he says. "You never want to back away from that."

While some may back away from stocks, and devote more to bond funds and the like "if they are really scared," Zoldan maintains that "there are some decent values in the equity market."

"Many pension plans have an equity income fund or a dividend-focused fund," he says. "I think that is probably a pretty good place to be accumulating positions today and not be thinking about the volatility if it is money you are not going to be using for the next five, 10, 15 years or so, until you are at that stage of retirement."

"There are some great companies that have consistently paid dividends and have been increasing dividends even over the past couple of years that are in these funds," Zoldan adds. "So if you can get 3% or more on a dividend that should be growing over time versus 3% in a U.S. Treasury that comes with some volatility, I think its not a bad place to be looking if you want to store some savings these days, as long as it’s not money you are going to need for the next couple of years."

Zoldan stresses that volatility and risk are not synonymous, especially for younger investors. If price is going down, you are getting more shares and dollar-cost averaging works to their advantage.

Unfortunately, it is much more difficult for people on the second half of their career.

"Within five or 10 years of retirement it becomes much more emotional," he says. "The contributions are a smaller percentage of the total pool. In those cases, it is OK to hold some cash for a while. You don’t have to have every percentage point increase in value, because if you hold in cash, you are preserving value and can just wait for a better day to take a position."

This article was republished with permission from The Street.


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