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Commodity Investing Shell Shocked
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Much of the focus in Washington has been on the fiscal cliff, yet a potentially more important cliff hanger is the debt ceiling debate that is likely to come to its precipice in February, 2013. Ironically, if no deal is reached on the fiscal cliff, the U.S. deficit problem would be solved before America hits the debt ceiling, as the scheduled tax increases and spending cuts would slash the deficit by trillions. The Congressional Budget Office (CBO), is projecting that public debt would fall from 75.8% of GDP in 2013 to 61.3% in 2022 in the no-deal scenario. In this scenario, government spending would be curbed, tax rates would rise and the economy would be pushed into recession. But despite the doom and gloom, we believe that cooler heads will prevail.

The ongoing fiscal shenanigans in Washington have investors positioning their portfolios for “the worst case scenario,” yet 2013 is shaping up to be another year of positive performance for stocks. While earnings growth will likely be sub par in 2013, improved quality, stability and visibility of earnings, should translate into higher stock multiples over the next year. For stocks, we continue to favour dividend growth and earnings quality as useful screens for stock selection.

But the good news may be out of the bag, as professional investors are already starting to increase their weightings toward stocks. According to a recent poll by Bloomberg, half of all investors are planning on adding stocks to their portfolio in the next six months, against just six percent planning cuts. Underpinning their bullish view is the expectation shared by more than three quarters of respondents that the White House and Congress will reach a short-term deal to avoid the fiscal cliff in the weeks ahead.

Further stoking investor interest in stocks is a Federal Reserve that appears likely to continue to be accommodative. In a recent speech in Toronto, by Chicago Fed President Charles Evans, he commented that he and other members of the policymaking FOMC are pushing for the Fed to stipulate publicly, that they will continue to keep interest rates extremely low and to continue with open-ended quantitative easing until the jobless rate falls below 6.5%.

With rates likely to remain low for some time to come, investors have been scrambling into dividend paying stocks and corporate bonds in a scramble for yield. One area in which investors have been loading-up, is in high-yield, or junk, bonds. High-yield bonds are issued by companies that aren’t strong enough financially to qualify for what’s known as an investment grade credit rating. They’re riskier investments than government or blue-chip companies, so they offer higher yields.

The current economic malaise is an ideal time in which to consider adding an exchange traded fund or actively managed portfolio of high-yield corporate debt to your portfolio. High-yield bonds tend to outperform both government bonds and stocks when the economy is growing slowly. When the economy is weak, they perform better than stocks, but lag behind the performance of corporate bonds. And when the economy is on a roll, they lag stocks but come out ahead when compared to corporate bonds.

Another area where investors have been flocking is to emerging market bonds. These bonds, like high-yield corporate bonds, are similar in that they combine higher risk and higher returns. Yet the financial underpinnings of emerging markets are actually quite strong, especially when compared with the developed world. Indonesia, Brazil, Mexico, and Russia all have lower unemployment rates and lower debt-to-GDP ratios than those in the United States, Canada and Britain.

Interest rates are unlikely to rise any time soon, and the economies of the developed world will remain sluggish in 2013 as the continued macro headwinds of too much debt and not enough action plague markets. In this kind of investment environment, investors should consider adding small amounts of high-yield bonds and emerging market debt to their investment portfolios, as a prudent strategy for boosting returns. Dividend paying stocks will likely continue to outperform in 2013, as multiple expansion becomes the order of the day, rather than the contraction we’ve seen of late.


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