By Robert Fitzwilson of The Portola Group

September 2 (King World News) - “Investors Must Keep Their Eye On The Ball”

There certainly are a great deal of worries and distractions for investors these days.  The volatility in the individual markets for equities, fixed income, housing, commodities and precious metals has been extreme.  It is always difficult to make “big calls.”  There are rarely moments in financial history when markets all move together.  It is fortunate as those moments typically occur under very bad circumstances.

There are legitimate concerns....

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We have the possibility of war in the Middle-East once again, currency meltdowns in two very important countries, India and Brazil, and interest rates and oil prices have spiked higher.  But what dominates the news is talk of who will be the next head of the Federal Reserve, as well as the odds of the so-called “tapering.”

War would clearly be a tremendous negative for the financial markets.  Our belief is that war will be avoided based upon the fact that the U.K. has opted out of any coalition, and stern warnings have been issued by both China and Russia, suggesting that an attack on Syria could have devastating consequences such as a much wider conflict.

Absent a war, the most important issue upon which to focus our attention is the looming debt ceiling debate in the United States.  While we prefer to call it the “spending ceiling,” our financial system relies upon the issuance of new debt.  We cannot fund the Federal deficit without issuing new debt, let alone funding the mounting and enormous off-balance sheet obligations such as Social Security and Medicare which are racing toward us like a runaway freight train.

These deficits also affects the issue of tapering.  Tapering is about reducing the amount of Federal Reserve purchases of mortgage-related securities, as well as U.S Treasury debt which is required to fund the government.  The amount being purchased is $85 billion per month, already a staggeringly large number.  Tapering implies a reduction in government spending as well as a further rise in interest rates.  The latter would send equity, bond and housing markets reeling.

The rise in interest rates in recent months cast a pall over the housing market.  That means fewer mortgage-related securities available for purchase by the Fed.  If the debt ceiling is truly capped, that will mean few Treasury securities for the Fed to buy.  The Fed already owns over 30% of the Treasury market, so a reduced supply and continued purchasing of what remains eventually implies that the Fed owns the Treasury market.  That would not be a desirable development.

The economies outside of the U.S. are continuing to weaken.  While headline inflation in the U.S. Is not seen as a problem, in places such as India, inflation is a very big problem.  India’s number one import is oil.  The rising oil price is wreaking havoc with their current account balance.  The skyrocketing price of onions, a very important staple, is causing social unrest.

In spite of all of this, the U.S. economy has held up surprisingly well.  Energy and technology are but a few of the sectors which have done well.  Large multinationals have also fared very well since 2009, as have companies providing productivity enhancing goods and services.  The consumer has been surprising in terms of their willingness to spend, and the housing market also was strong up until the recent rise in interest rates.

But all of that strength is beginning to soften.  A continuation of the rise in commodity prices and interest rates, combined with dismal employment and housing numbers could send the U.S. economy and the financial markets into a tailspin.  Such a downdraft would rapidly spread throughout the global economy.

This brings us back to the issue of the debt ceiling.  Without an increase, the consequences outlined above are highly likely to ensue.  While we are no fan of the overspending that got us here, it is what it is.  Unless we allow for more debt to be created, the consequences will be swift and unpleasant.

We have been emphasizing energy, metals and miners, and high-growth productivity and technology enhancing equities, while avoiding fixed income and equities that are priced as fixed income proxies.

That emphasis has been shown to be correct.  Since the end of the second quarter, the precious metals and the mining companies that produce them have been standout performers.  Companies involved in the U.S. oil renaissance, as well as emerging technologies as 3-D printing and medical/biotech, have also seen many stellar performances.  Fixed income and proxies for fixed income such as utilities were devastated.

The debt ceiling resolution will tell the tale going forward.  Without a higher limit, we could see an implosion in the financial markets and the interconnected global economy.  What happens next depends upon how high the limit is raised and what surprises the Fed might have in store for us.  Until we have a decision, one thing we know with great certainty is that what lies ahead is enormous and continuing volatility and uncertainty.  It is important that investors stay focused by keeping their eye on the ball during this chaotic period and not lose sight of why they have made investments in key financial assets such as a few of those which I highlighted above.”

IMPORTANT - Two extraordinary King World News audio interviews with 50-year market veteran Art Cashin and former U.S. Treasury Official Dr. Paul Craig Roberts are available now, you can listen to them by CLICKING HERE.

© 2013 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

The audio interviews with Dr. Paul Craig Roberts, Art Cashin, James Turk, Eric Sprott, Egon von Greyerz, Michael Pento, James Dines, William Kaye, Grant Williams, Hugo Salinas Price and Marc Faber are available now. Also, other outstanding recent KWN interviews include Jim Grant and Felix Zulauf to listen CLICKING HERE.

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