Try as I might to steer clear of talking politics, it is front and center again. While analyzing investments and providing financial market outlooks aren’t easy jobs in any environment, they certainly aren’t in one that seems to have a new “bogeyman” around every corner.
Whether that would be slow economic growth here in the U.S., the pending doom of the Eurozone, a slowdown in China or new Middle East tensions, the mantra that “markets climb a wall of worry” never seems more true than today. Adding to all of this worry is the political environment in the U.S. and the upcoming “fiscal cliff” at the end of the year.
Who’s your money on?
While the upcoming election is one thing that I am not going to touch on much, I do look at the Iowa Electronic Markets website to see what the election odds look like. Real people are putting down money to essentially bet on the outcome. Right now it appears as though President Obama will be re-elected and Republicans will gain control of Congress. So, going with that as an outcome, what does the end of the year hold for investors worrying about the “fiscal cliff”?
First of all, what is the “fiscal cliff”? Well, at the end of the year, without new legislation, you get a combination of:
- tax increases through the expiration of the Bush tax cuts and the temporary payroll tax cuts along with
- some spending cuts in several discretionary budget areas.
Basically, if this happens, according to the Congressional Budget Office (CBO), the U.S. economy will likely fall into recession in the first half of 2013.
What’s over the precipice?
This chart from the CBO’s website presents two scenarios: the CBO’s Extended Baseline (if the fiscal cliff occurs) and the CBO’s Extended Alternative (if most current policies are extended). Interestingly, Debt-to-GDP and the Budget Deficit are improved dramatically if the fiscal cliff were to happen as opposed to extending it out. The problem here again is the short-term economic ramifications of allowing this to occur.
Taxes reverting back to pre-Bush era will affect everyone. Tax rates go up across the board.
- The individual income tax rates will revert to 15, 28, 31, 36 and 39.6 percent.
- The capital gains rate will increase to 20 percent and dividends will be taxed at ordinary income rates.
- The 10 percent bracket is eliminated hurting lower income earners.
Also don’t forget, estate taxes will jump from 35 percent to 55 percent! Just thinking about this probably is giving accountants everywhere a headache!
The fiscal cliff is a big unknown right now as it will unlikely be resolved by the end of the year given the election. So, while we may get some retroactive relief passed next year, investors won’t know exactly what that will look like.
If the Iowa Electronics Markets election outcomes prove correct, can the Republican Congress and President Obama work together to hammer out a compromise that will help ease the severity of the “Fiscal Cliff”? Since everyone is impacted by this, rich and poor, there may be more incentive than usual to compromise, but it might not be pretty.
Sounds like good analysis. But what do you suggest we can do now to prepare for the fiscal cliff?
Troy,
Good artical Troy and thank your for the info. With the mess in the Eurozone combined with all the other uncertainty overseas are we adjusting any of our investment models to decrease some of the exposure in these areas? Also, I wondering if COUNTRY would ever consider offering some indexed funds for our clients as most of these carry lower fees and have performed well. Just curious!
Thanks again Troy!
Josh
The question is: how do we get the Republican Congress and President Obama to work together. The production in congress has been agonizing to watch.
Excellent summary.
If Obama wins nothing will get done as he will not work with congress this said we are headed for the cliff and a big drop in the markets and more unemployment and less improvement in spendable income! Hope I am wrong but signs do not look good to me!
Aren’t Obama and the Congress in this together? Sort of hard to blame one side over the other if you look at it objectively. Maybe both sides could learn something about compromise and work together for the good of the country instead of trying to constantly advance their partisan agendas? As Matt quotes below, and I paraphrase, we need more partnership, less partisanship. If it’s good for the country, let’s do it and not try to tag on a million special interest amendments – both sides are guilty of this and it needs to stop.
“What we need is partnership, not partisanship” President Bill Clinton
Glen-
As far as preparing for the fiscal cliff, we recommend that our clients stick to their long-term plans. The market is a good discounting mechanism and trying to time it is very difficult. We would also advise clients to speak to their accountants and estate planning lawyers in regards to things like capital gains and tax planning. If an investor has been slowly selling out a position with a large capital gain, it may make sense to accelerate that plan based on the potential increase in the capital gains rate next year. Again, talk to your accountants and lawyers on your individual situation.
Josh-
We already had reduced exposure relative to our benchmarks in certain areas, but we still have exposure and remain diversified. In investing, last year’s losers often become this year’s winners and vice versa. There are good global companies that happen to be domiciled in Europe. We think that in some cases, there already has been some discounting done on some international investments and they potentially make for attractive longer-term opportunities.
Ken and Julie-
Again trying to guess the outcome is pretty difficult at this point. Getting President Obama and a Republican Congress to work together is no small task, but in this case, my thinking is that they almost have to. Republicans will work with the President because they don’t want to be blamed for the massive tax increase. The President will work with Congress because many programs that are important to Democrats would be on the chopping block as part of the spending cuts, not to mention that the 10% tax bracket goes away and the low income earner gets hurt as well the rich. Again tough to say for sure, but there does appear to be some incentive.