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Three Bond Mutual Funds to Consider as Sequestration Begins

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As we prepare for another "continuing resolution," it's important to pay special attention to the fixed income portion of your portfolio.

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Obviously something has to give. The Democrats believe raising taxes is the answer and the Republicans think cutting spending is the answer. The truth is, both sides are right, spending has to be reduced and taxes need to be raised. With the passing of the "fiscal cliff" taxes were indeed raised, but now spending needs to be addressed. However, with politicians unwilling to compromise like they did on the "cliff," the sequestration process has begun; and the dateline looks like this.

March 1 – The Sequester: Large spending cuts are set to begin. About half would be in defense. This is set to subtract 0.7 percentage point from GDP growth this year absent any multiplier effects. However, it's unclear when the cuts to spending will be made (if they are not postponed again) and exactly what will be cut.

March 27 – The Continuing Resolution: Without a real budget (last seen in 2009), federal spending has been authorized through a series of CRs. Most likely, we'll see another one.

May 19 – The Debt Ceiling: Treasury reported that the ceiling was breached on December 31, 2012 but (through "extraordinary measures") the drop dead date was expected to be in the second half of February. There was not enough time for the new Congress to work on a possible budget deal. Lawmakers now have until mid-May to achieve a plan to reduce the deficit over the long term.

As I understand it, the spending cuts -- well actually they are not really cuts but simply a reduction in the rate of spending increases -- will not actually "bite" until March 27 when the government officially runs out of money unless rescued by another continuing resolution. Yet, I remain steadfast in the belief there will be a solution. One solution would be to place a "cap" on all tax deductions of say 2%. That would mean at a marginal tax rate of 25%, a 2% cap would limit deductions/exclusions to 8% of an individual's adjusted gross income. According to Martin Feldstein, such a cap on tax deductions would reduce the national debt by $2 trillion over a decade (for more, see the Wall Street Journal's article dated Feb. 21.

Consistent with these thoughts, I think you need to be very careful with the fixed income allocation of your portfolio. The three bond mutual funds I favor, where I have spent time with the portfolio managers and think they are positioned for the type of interest rate climate I think is coming, are Putnam International Diversification Fund (MUTF:PDINX) managed by Bill Kohli, Lord Abbett Bond Debenture Fund (MUTF:LBNDX) managed by Chris Towle, and the Van Eck Unconstrained Emerging Markets Bond Fund (MUTF:EMBAX) managed by Eric Fine.

As for the stock market, last Thursday the Dow Jones Industrial Average (INDEXDJX:.DJI) came within 15 points of hitting a new all-time high, but failed to accomplish that. Subsequently, on Friday I stated that not only did the Industrials fail to make a new all-time high, but the S&P 500 (INDEXSP:.INX) likewise failed to make a new reaction high above its February 19, 2013 closing high of 1530.94. Therefore, we should look for the equity markets to flop/chop around with attempts to sell stocks off that don't gain much downside traction. Such action should allow the SPX, and the INDU, to rebuild their internal energy, leading to an upside breakout due by mid-month. Consistent with that outlook, I remain a buyer of stocks on pullbacks.

The call for this week: Well, it was close, but no cigar last Thursday as the Industrials got within 15 points of their all-time high of 14164.53 made on October 9, 2007. Given that upside failure, it would not be surprising to see some downside attempts this week that don't gain much traction. That said, we still have not seen three consecutive Downside Days for the Dow, which is what is required to break the back of the current Buying Stampede. Accordingly, today is session 43 in that upside skein, making this the second longest stampede chronicled in my notes of some 50 years (the longest is 53 sessions).
No positions in stocks mentioned.
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