Paul Dietrich's Global Investing Trends Report

Foxhall Capital’s View On The Debt Ceiling Political Drama

Posted July 19, 2011 · 0 Comments

A number of people have asked me will Foxhall Capital employ any defensive measures, like going to cash if our brave political leaders continue to “play chicken” with the debt ceiling.

Theoretically, if our Foxhall Capital technical signals trigger a bear market drop, we would immediately move to our defensive strategy.

But I don’t think this will happen!  If our wise and courageous political leaders were to allow the U.S. government to default, the stock market would definitely drop for a few days, as would the U.S. Treasury bond markets and almost all other financial assets.  Commodities, like gold and oil would shoot up.  Gold went over $1600 an ounce this week, capping the longest rally in 31 years.  Silver rebounded to over $40 an ounce this week.

If a U.S. Government default occurred, I expect that congress would reconsider their action after our veterans and retired neighbors expecting their military pensions and social security checks started convening on their congressmen and senator’s lawns carrying torches, pitchforks and shotguns.

As many of you know, I live outside of Washington DC in Virginia.  Over the past few days I have spoken with two leading U.S. senators and three congressmen.  They all say that there is a majority of votes in both the House and Senate for at least the scaled back Plan B or Plan C.  None of them believe there will be a default.  But all of them said this little political theater would play out until the 11th hour and then one of the back up plans would most likely be voted on and passed.

What no one will tell the truth about is that even if the Republicans are successful in getting the Democrats to agree to $2 trillion in cuts (with no tax increases) over the next decade, that is a savings of only $200 billion a year.  The budget for 2012 calls for a $1.4 trillion deficit and a similar deficit for every year during the next decade.  If the Republicans are able to cut $200 billion that still leaves a deficit of $1.2 trillion that has to be funded each year.

The bottom line is that the government will continue to print money to fund massive deficits over the next decade.  That is why commodities like oil and gold are going to be such an important component in Foxhall client portfolios in an attempt to offset the loss of our client’s purchasing power due to inflation that will be a direct result of the government expansion of the U.S. money supply.

What Are The Debt Ceiling Back Up Plans:

If the Republicans cannot pass $2.4 trillion in budget cuts over the next decade in order to raise the debt ceiling by $2.4 trillion, the Plan B back up strategy will settle for spending cuts of $1 trillion to $1.5 trillion, so long as there are no tax increases. 

If Plan B doesn’t work, the Plan C back up strategy is the plan that Senate Republican Leader, Mitch McConnell has crafted, which would essentially lay the debt ceiling increase at the feet of President Obama and the Democrats.  Senate Democratic Leader Harry Reid is also working with McConnell to make this plan more palatable to senate Democrats.
In addition, Democrats want to include about $1.5 trillion in spending cuts, including military cuts, along with a payroll tax-cut extension to boost the economy and an agreement on funding levels for the coming two fiscal years to avoid further budget showdowns.
The plan would also include a special deficit-reduction committee, made up of equal numbers of Republicans and Democrats, that would examine more sensitive budget topics like taxes and benefits. The panel would be guaranteed a vote on its findings, due by the end of the year.
If Plan C is rejected, everyone seems to agree that as a last ditch effort, the Plan D back up strategy, which would call for $500 billion in cuts and raise the debt ceiling by $500 billion and give the congress and the President another five months to extend this political theater and their prime time television appearances to persuade the voters how hard they are working on our behalf!

Winston Churchill once said, “Americans always do the right thing, but only after they have tried everything else.”

One way or another, I believe we will not have a default.  But until this is resolved the stock market will be grading our politicians each day and they will not be kind.  The market will be rocky over the next few weeks.  But after the debt ceiling is raised, I believe there will be a collective sigh of relief on Wall Street and we could see a substantial upward swing in the stock market. 

I think any investor who gets nervous and exits the stock market now will lose a lot of money in they will miss all of the upswing in the markets when this political drama has concluded. 

There Is No Way To Time These Political Dramas And Only A Fool Would Try!

As I have mentioned in previous Global Outlooks, the fundamentals of the companies that make up the Dow and the S&P 500 Index are in great shape, primarily because of robust earnings from Asia and emerging markets.  Despite being overshadowed by the debt ceiling debate, we had a solid week of earnings reports last week where 39 companies in the S&P 500 Index posted results with 74% reporting earnings that topped Wall Street estimates.  Analysts expected 13% growth in earnings for this past quarter. 

In the end, earnings primarily drive long-term price trends in the stock market.

Making Sense of the Taxes, Entitlements and Federal Debt Crisis

A week ago in an appearance on CNBC’s program “The Call” I was asked about the long-term debt crisis.  I have also received emails from clients and financial planners asking questions about this, sometimes confusing debate.

I thought I would share with you a brief summary of what this debate is all about.  The material and charts reprinted below were published by Doug Short, and I am grateful for his permission to use his raw material and charts.

Below is a look at the U.S. government balance sheet for the last year and the official government projections for 2011 and the decade beyond.  With the congressional showdown on the debt ceiling, it seems particularly appropriate to understand the broader context.

As we can see, 2010 entitlement costs exceeded the entire tax revenue for the year — personal, corporate, and social.  However, according to the Congressional Budget Office (CBO), entitlements only accounted for about 55% of 2010 spending. Defense spending took another 20%, nondefense discretionary 19%, and interest payments 6%. Thus we ended 2010 with a deficit of $1.294 trillion.
For 2011, the CBO projects a staggering $1.48 trillion deficit.  And we can be fairly certain that the actual 2011 deficit, which we'll learn next year, will be higher than the projection.
Now let's put the current deficit into the larger pattern of federal spending behavior.  Below are two charts from a combination of the CBO historical data since 1971 and their budget projections for 2011-2021. The first chart shows the astonishing growth of entitlements.

The next chart shows the projected gap between revenues and outlays over the next decade together with an overlay of the accelerating growth of public debt.

Meanwhile Congress continues to squabble over the inevitable increase in the debt ceiling.  Soon, of course, that showdown will be resolved — at least for the time being — and the prospect of budget paralysis will become the new inevitability.  Why?  Because an election year will take place next year in 2012.  Posturing will prevail, with little hope for a rational resolution to the budget mess we face.
The next chart replaces real debt with the debt-to-GDP (Gross Domestic Product) ratio, which gives us a better idea of the true debt burden.  Against the backdrop of U.S. history, the contours of the first two-thirds of the chart are easy to understand.  Debt-to-GDP soared with the U.S. entry into World War I, as did the personal tax rates.  After the war the ratio gradually dropped, this time against the backdrop of the "Roaring Twenties."  The Crash of 1929 and Great Depression triggered a rise in the ratio to levels exceeding the peak in World War I.  Logically enough, World War II brought about another rapid rise in Debt-to-GDP.  War costs drove the ratio to a peak above 120% in 1946.

As we can readily see, only once in U.S. history, the WWII debt peak of 1945-46, have we had a higher Debt-to-GDP ratio than the current six-year forecast.

Below is a snapshot of Debt-to-GDP and presidential politics:

This explanation probably doesn’t clear up all the confusion, but the charts do point to the fact that if we don’t cut spending and reform entitlements soon, this country is going to be in big trouble financially over the next decade.

We have to either “bite the bullet” now and suffer a little pain, or “kick-the-can-down-the-road” and then find ourselves where Greece is today.  Then the suffering will be really painful.

With a $14 trillion debt right now and one projected to rise to $19 trillion over the next 10 years, even if congress in the next few weeks finds cuts over the next 10 years worth $4 trillion, that will still leave us with a $15 trillion deficit in 10 years.  It will be like treading water for the next decade.

I hate to be a cynic, but I just don’t have a lot of faith in politicians—either Republicans or Democrats.  Eventually they will vote to raise the debt ceiling, declare victory and proclaim to their constituents that they have saved America by passing 10 years of budget cuts that will, in the end, leave us right where we are now.

It’s not a pretty picture!

Investors Must Protect Themselves From The Politicians

At Foxhall, we believe the best way to try and protect your investments from the politicians and from the inflation that will inevitably come because of future annual trillion dollar plus deficits that need to be funded by printing money, is through the use of the Foxhall’s Dual Investment Strategy that keeps investors largely invested during long-term bull markets and once a long-term bear market is identified, to quickly move investors out of stocks and into cash, treasury bonds or other investments that could protect a clients principal.

Second, we believe that every portfolio should have a significant exposure to commodity and commodity producers like oil, gold and other precious metals, in an attempt to protect clients against unforeseen and unpredictable  “Black Swan” disasters and to try and protect the purchasing power of client accounts against the ravages of inflation caused by our politicians.

At the moment, there are not many things we can do to deal with our less than courageous politicians in Washington DC, but you can attempt to protect your investment portfolios in an investment strategy like Foxhall’s Dual Investment Strategy that will at least help investors try and protect themselves from what we can know is coming and can see coming in the charts above.


—Paul Dietrich


Disclosures: The opinions and portfolio information provided in the Foxhall Global Outlook are subject to change at any time, and are not to be construed as advice for any individual nor as an offer or solicitation of an offer for purchase or sale of any security. Client accounts may differ from model allocations due to many reasons. All investment strategies offer the potential for loss as well as gain. Individuals should consult with their financial professional to determine an
investment strategy appropriate for their objectives, risk level, and time horizon prior to investing. Past performance is not a guarantee of future performance.

Foxhall Capital Management, Inc. is a registered investment adviser with the U.S. Securities and Ex‐change Commission (SEC) under the Investment Advisers Act of 1940. The firm is defined as the Foxhall Capital Global ETF, 401(k) and Stock Series divisions, which manage a variety of ETF, 401(k) and Stock strategies in bundled fee and non‐bundled fee accounts for primarily U.S. clients. The firm was redefined as of 12/1/08 due to the creation of the 401(k) Series division. A complete list and description of all firm composites and their compliant presentations are available upon request.

Foxhall Capital Management, Inc. claims compliance with the Global Investment Performance Standards (GIPS®). Foxhall Capital Management has been GIPS verified for the periods 12/31/99 – 12/31/08 by Beacon Verification Services. The ETF Series composites have received a performance examination for the period since inception through December 31, 2008. A copy of the verification report is available upon request.

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About Paul Dietrich
Paul Dietrich is the Chairman, CEO and Co-Chief Investment Officer of Foxhall Capital Management, Inc. (Foxhall).  Foxhall currently manages investments for individuals, mutual funds and private institutions throughout the United States. Paul Dietrich is also a portfolio manager to a publicly traded mutual fund, the Foxhall Global Trends Fund.
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