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Debt Ceiling Showdown And Dividends

|Includes: COP, DUK, ED, International Business Machines Corporation (IBM), MCD, T, VZ, XOM
As of this writing, there's no way to know what the outcome, if any, will be of the political showdown in Washington on the debt ceiling limit. To say the situation was changeable was understating it. At the end of Friday, July 25th, it appeared that a tentative compromise deal broke down although there were indications of possible weekend work to get something done. Maybe. As most investors know, markets hate uncertainty, so the formula is there for the markets to shudder in displeasure again in the short term. This has the potential of course to ramp up volatility once again. This is rarely good news for investors.

Uncertainty Reigns

More disturbing than even the short term gridlock for investors is the possibility-or probability, as politicians are involved-that the debt ceiling limit and the much larger fiscal issues it involves will not only receive the same lack of direction from Washington that these crucial issues have, but that such directionless policies will continue for some time in the future. This view could be amended if the politicians shock us all and come to some sort of an actual deal that has a realistic chance of being put into place. Investors waiting on politicians to solve such problems, though, is historically unwise.

What Should Investors Do?

Investors should probably brace for some volatility, as I said. Despite the strong earnings reports coming out from the second quarter and the intimations that the weak economic recovery is at least edging forward, the debt ceiling debate may in the short term overcome this better news. It's not just the US, either, and it isn't only ordinary investors who are taking note. Legendary speculator George Soros has moved to a larger cash position because he admits he can't figure out the direction of the markets. Add to the US fiscal debate the European difficulties, as the eurozone is still wrestling with the details of how to address not only Greek debt but the further bruising of Greece's neighbors when the Greek economy lands hard.

Some Possible Outcomes

While the possibility of technical default is low, it's still a potential outcome for the US debate as this is written. A debt downgrade is another. Either of these would send interest rates soaring, and the financial markets would react badly, again an understatement. Default aside, if the warring parties in Washington do come to an agreement with a compromise including some austerity measures, one thing clear is that if the government is forced to cut back spending in the deal, we will be in for a slower-growth economy. But we're already in a slow growth mode, you say? True enough, so investors should note that.

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(Comparison of percentage & direction of moves of 10 Year Treasury Note vs. S & P 500, last five years)

Where Should Investors Look?

There's no sense parsing the numbers yet for a contracted spending role from the government, which again, may or may not happen, but the slow growth economy is here anyway. It might be a question of whether it's slow or slower growth. The likelihood of any further stimulus, such as a "stealth QE 3," becomes less and less likely, however, each day the rancor picks up on the debt debate.

And remember, as to the markets, the stimulus of QE 2 certainly had to fuel the pickup in the stocks, as QE 2 ultimately was an asset stimulus move, not really so much an economy stimulus. In other words, the stock market benefited, and won't have that extra cash pumped into it. But cutbacks on infrastructure, government workers, defense contracting, government programs and the like will have negative economic impact. And if there is a debt agreement we probably will continue to have relatively low interest rates due to slow growth, yet there will still be an inflationary push from commodity demand. If this plays out badly, slow GDP growth of 1% or less along with $125-$150 barrel of oil next year would be an ugly possibility. Investors shouldn't hide their heads, though, they should understand the situation and act accordingly.

Dividends Still Matter

In a slow-growth, contracted spending environment where the markets may settle into a trading range or at least a period less likely to drive averages up, unlike the S & P's rise, or rebound, of the last year, high-flying growth stocks and other such winners in the last year will be harder to come by. Whatever your particular investing style or tolerance for risk, investing in some dividend stocks to spread your risk and buttress against the unpleasant scenarios possible up ahead can help.

Dividends And Diversification

The topic of diversification is too large here to tackle, but in addition to whatever other stocks you decide to buy or sell, you should have some gold, despite what Ben Bernanke thinks of it, perhaps a bit of foreign currency, notably China, and different types of dividend stocks as well. It's not bad to have some blue-chippers, the IBM's (NYSE: IBM) and the McDonald's (NYSE: MCD), or even stable and relatively safe Verizon (NYSE: VZ) or AT & T (NYSE: T). But you might also expand and have some strong utilities, Duke Energy (NYSE: DUK) or Con Edison (NYSE: ED), but you shouldn't stop there. Have a few high-yielders sprinkled in there, perhaps some energy MLPs to play the demand on oil and gas while getting a smoother ride than the majors like Exxon Mobil (NYSE: XOM) or Conoco Phillips (NYSE: COP), which are far more reactive to the sometimes dramatic shifts in oil prices. Natural resources stocks with dividends, such as timber, metals and energy via Canadian companies with decent payouts are another place to look to protect yourself.

Ultimately nobody knows for sure where the markets will go, so that's all the more reason to be prepared to protect your profits.

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