Building on a Wall of Worry

 

"What if..."

 Last week was down; this week was up, but we gave it all back on Friday. Overall stocks are trapped in a trading range. At some point soon that range will be broken. I’m betting it will be to the upside.

Whether it is the elections, the economy, jobs, or the coming Fiscal Cliff, investors are schizophrenic about the future. The Presidential candidates have contributed to that tension by weaving a myth that their positions on all of the above issues will be drastically different. This “either/or” atmosphere among the electorate is impacting the financial markets, which should know better by now. As I have said often in the past, what candidates say during a campaign and what they do after they get elected are vastly different.

This week’s earnings have also thrown investors for a loop. Earnings announcements in a number of sectors, especially in some big name technology stocks, have been less than stellar.

There are some real issues facing investors going forward, however. If the Bush tax cuts are allowed to expire at the end of the year, the long term capital gains tax will rise from 15% to 20%. Taxes on dividends will also see a hike from 15% to as high as 39.6%, depending on what one’s income tax bracket is.

Readers should be aware that dividend stocks have been in a bull market for some time now because they offer an equivalent or higher yield than many bonds. At the same time, dividend stocks are considered a less aggressive (more defensive) way to invest in the stock market. As a result, they are over-owned and could be at risk.

Many accountants are advising clients to sell their dividend winners now or at least before the end of the year, rather than pay more in taxes later.  It is called tax harvesting and is a common practice at the end of each year. As such, some of the year’s biggest equity winners in areas like home building, commodity chemicals, household appliances, wireless telecom, biotech, etc. could see a bout of profit-taking.

The problem with that strategy is that no one knows for sure whether the Lame Duck Congress will extend the cuts or not. Then there are the presidential candidates to contend with. Romney is in favor of an extension across the board while President Obama is still insisting on raising taxes for those making over $250,000. By now, even the government’s budget office admits that those extra taxes on the “rich” will barely budge our deficit.  Even Bill Clinton thinks the president’s stand is stupid.

Nonetheless, in an election year, by making it an issue, the Democrats hope to wrestle a few more votes to their side in this closely-contested race. My own belief is that if Obama wins, he will compromise, drop his objection and extend the cuts for everyone. If Romney wins it is a sure bet those tax cuts will be extended. If so, those investors who sell now will be leaving a lot of dividends and potential gains on the table.

The point is that there is a lot of uncertainty. The elections are still over two weeks off. After that, we get to deal with all the Fiscal Cliff issues through the end of the year and no one knows the outcome. The only thing positive in that scenario is that stock markets usually do well when the worry index begins to climb. Well, it’s climbing now, but this week the markets went the wrong way.

 

 

 

 

 

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