Business Forum: Investors coming out from cover

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It turns out the sky over Washington is not falling, at least not any time soon.

The Congressional Budget Office now estimates the federal budget deficit will continue to shrink in 2013 to 4 percent of gross domestic product -- less than half the shortfall of 10.1 percent in 2009, and in line with levels of the past three decades.

The improvement comes as tax receipts rise alongside the strengthening economy and markets, and sequester-related spending cuts kick in. Even Standard & Poor's, the credit rating agency that in 2011 famously downgraded the nation's debt, has revised its outlook upward.

The progress in government finances means that a persistent fear for investors -- the potential for a fiscal crisis -- is unlikely to be realized in the near term.

With the D.C. firmament still in place, investors are coming out from cover.

"Crisis" investments such as gold have plummeted and inflation expectations have fallen. The dollar has risen nearly 5 percent this year versus major trading partner currencies, and stocks have surged since the resolution of the fiscal cliff in January.

In short, investors no longer fear an imminent budget crisis in Washington, and thus a major obstacle to higher equity prices has been removed.

The shrinking deficit also changes the political landscape in D.C., where fears over the debt ceiling, rating downgrades, and the fiscal cliff have transfixed investors. Deficit-related sparring should subside, and the economy's improvement despite sequester spending cuts means investors now regard Beltway alarmists as they would Chicken Little.

Markets can now shift their focus from Washington's budget woes, back to where it belongs: corporate results. Indeed, while investors have been paralyzed by fear of rising deficits, corporate earnings have climbed 125 percent since the recession low to drive a 140 percent price return for the S&P 500.

None of this is to say that Washington's problems are solved. The nation still faces serious long-term budget challenges, none of which require rehearsing here.

However, like storm clouds on the horizon, the danger is not imminent and can still be averted. This means investors who have sheltered their portfolios in cash ought to reconsider their approach. With no budget crisis in the near-term forecast, stocks have the potential for further gains.

Indeed, markets don't always require sunny skies to rally. Sometimes they just need the rain not to fall.


Brian Koble is director of research for Hefren-Tillotson Inc., a Downtown-based investment firm.


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