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Taking the Long View on Your Investments

By Kathryn Tully

No matter who is in the White House today, here are some long–term issues that investors will need to keep an eye on.

The U.S. presidential election kept investors – especially affluent investors – guessing all year about how the outcome would affect them, with a fair amount of the uncertainty focused on tax rates and whether itemized deductions, such as charitable deductions, could be eliminated.

It seems like some changes are inevitable. When Erskine Bowles, Co–Chair of the bipartisan National Commission on Fiscal Responsibility and Reform, spoke at BBVA Compass's economic forum in Dallas in October, he said that a new bipartisan agreement in Congress including both tax increases and spending cuts was essential to address the $16 trillion national debt, which he called "a cancer that will destroy our country."

But what is far less clear is whether or not the investment markets will be affected by how things play out in Washington. Here are some issues that investors should consider, no matter who is in the White House and how things play out on Capitol Hill:

  1. Historically, equity market performance has not been linked to which party is in office. One of the most discussed research papers on this subject, a 2003 article in the Journal of Finance by Pedro Santa–Clara, Professor of Finance at the Nova School of Business and Economics, and Rossen Valkanov, Professor of Finance at the Rady School of Management at UC San Diego, purported to show that since 1928, the performance of large stocks was nine percent higher during Democratic administrations than during Republican ones. However, a study one year later by Sean D. Campbell and Canlin Li, two economists at the Federal Reserve, showed that those 2003 findings did not account for swings in market volatility, and concluded that stock market returns are not connected at all to which party wins presidential elections. Conclusion? If history is any guide, investors may want to pause before rushing out to rebalance their stock portfolios, and instead stick to a long–term plan.
  2. The low–yield environment does not appear to be going away anytime soon. James Grant, Founder of Grant's Interest Rate Observer , pointed out at a fixed income conference in October that as long as central banks around the world, including the Fed, are prepared to pump cash into the economy to try to speed up growth, interest rates offered on bonds will stay low. "The Fed has somehow managed to take the income out of fixed income," Grant said. "We live in a world of man–handled interest rates. The Fed and other central banks will continue to do this."
  3. Inflation is a possibility. A much–discussed concern among some economists is that sustained central bank intervention risks a rise in inflation. Grant said that in the U.S., indices measuring short–and long–term interest rate volatility are very low and are not pricing in the risk that inflation could rise. "How often do we hear that we mustn't worry about new inflation because the labor markets and product markets are slack?" he said. "The market has in its head that the Fed is in charge, and that inflation is a distant concern." But with even 10–year treasury bonds yielding less than three percent, he said that it wouldn't take much of an increase in inflation to wipe out bond investors' returns altogether.
  4. The appeal of "real" assets, such as real estate, gold, and other commodities may continue. Not only are these asset classes currently offering higher returns, they are offering a decent inflation hedge. But Grant pointed out that unlike the stock and bond markets, which are vast, there are only so many real assets to go around, which in periods of high demand, inevitable pushed prices up. "I'm bullish on gold, but I can't defend its current $1,750 price any more than I could a $2,000 price."

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