Look out: Capital gains taxes going up
Beware of market declines as the end of the year gets closer.
Now that the election is over, everyone is talking about the elephant in the room. Our deficit and debt levels are outrageous and are causing the rest of the world to question our integrity as a nation. Although the U.S. dollar continues to be the reserve currency of choice for safe haven investors, many people wonder just how safe Treasury bonds can be when the United States continues to rack up trillions of dollars of new debt on what seems like an endless basis.
With President Barack Obama back in office everyone expects some level of higher taxes and lower spending, but no one wants to see the fiscal cliff.
Touted by the media, the fiscal cliff has brought eyeballs to newspapers, financial websites, and business journals, but this coined phrase is not nearly as black and white as it may seem to the passive eye. Some people actually believe that if we avert the fiscal cliff everything will be fine, but many of those people are also forgetting about the elephant in the room. The fiscal cliff is a combination of higher taxes and lower government spending, we all know that, but the negotiations that might help us avert going over that cliff are also entertaining the same two economic headwinds.
In order to reach an agreement to avert the fiscal cliff, our government must reach an agreement on higher taxes and lower spending. These are each material economic headwinds that are coming very soon, whether we go over the fiscal cliff or not. In fact, I will go so far as to tell you that capital gains taxes will be going up next year. That alone should be reason to worry.
Of course, I also believe that other taxes will increase; I know government spending will also decline, but it is the capital gains tax that actually might be most important to us as investors in the stock market. Although buy-and-hold investors are still underwater from where they were in 2007 and even 2000 for that matter, proactive traders or other lucky investors who got in nearer the lows are holding significant capital gains. If capital gains taxes were to revert to normal income taxes the difference in actual after-tax performance would be significant.
For example, for every $100 million invested that is carrying a 30% gain, or $30 million in unrealized profits, the difference between selling at the end of 2012 versus any time afterwards would prevent an effectual doubling up on income tax. In this example, selling in 2012 could save about $6 million in taxes.
Unless you feel the economy is good enough to allow the stock market to continue to increase beyond these multiyear highs, a reasonable investment professional will seriously consider securing gains before the end of the year. Not all investors would do this, but enough investors are worried about it to rationalize lower market levels in the months ahead.
With that understood and in line with my macroeconomic work (The Investment Rate), which is much more dire than merely what the higher taxes-lower spending headwinds might suggest, I continue to advise all people to move their entire 401(k) positions to cash, sell all buy-and-hold investments, and for now we are still close enough to relative market highs to make short positions OK. Right before I wrote this article, I ran a real time filter for longer-term short ideas using the Long-Term Trading Filter Tool on Stock Traders Daily, and four stocks appeared prominent at the list: the Financial Sector SPDR (XLF), International Paper (IP), Cardinal Health (CAH) and PepsiCo (PEP).
If you follow these, use integrated risk controls because the technical patterns of the market tell us a short-term bounce can come. But the declines from longer-term resistance towards longer-term support have already begun, so increases from here will likely be short lived and the economic headwinds that are coming will change the sentiment on the street considerably.
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