clifp
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
- Joined
- Oct 27, 2006
- Messages
- 7,733
Yesterday's sell off means that some people are (over) reacting to the election, but I think it reflects the realization that now the fiscal cliff is looming. Expect volatility until it becomes clearer that this will be addressed, which of course it will be. Meanwhile the underlying fundamentals of the US economy are improving.
I am getting ready to do some rebalancing and will wait for the next bounce before selling some equities.
I am not sure that it is an overreaction. I think the election which basically maintains the status quo, increases the likelihood that nothing will be done to deal with either the short term or long term fiscal problems.
The expiration of the Bush Tax cuts alone dramatically changes the investment situation, much less all of the other issues.
In my case I have a portfolio heavily invested in dividend stocks. Over the last few years, my formerly unloved and sleepy dividend stocks, have become the hot new girl in school, gained popularity and the price has risen. In many cases to levels which I think are too high on absolute basis but not necessarily on a relative basis to other investments.
The tax cuts expiring means that dividends are now treated as ordinary income. In fact since the preferential treatment for dividends was not part of the original tax cuts but came about in 2003 (I think) law. There is a reasonable chance the Congress will drop it all together.
Now normally, I'd look at stock with a 4% yield at this time of year and think. Is the price above my target? If yes (and it generally is) I'd say is there an alternative investments that I can make that will provide me an after tax income stream greater than the stock. Right now after accounting for the 15% capital gains tax the answer is generally no.
However, if I think it is likely that dividends will be treated as income the numbers change. Now suddenly the 4% yield which was 3.4% after tax now only provides an a 2.88% yield for a 28% tax bracket. That number could drop to just 2% for wealthy person in California.
Then I factor in that I gain an additional 13% if I sale this year as opposed to this year and suddenly holding the stock looks far less attractive even if I don't have an alternative investment. Then I ask myself have I figured out something the rest of the market hasn't, of course not. All the hedge fund manager etc know this. On the other hand do I think the Joe Blow who a Dividend ETF or mutual fund has figured this out or even some of the guys passively managing money. No I don't. So maybe I should join the "smart money"and sell now. Of course if they do extend the tax cuts I am probably better off holding, rather than timing the market.
Still I figure the expiration of the tax cuts means a roughly 15% decrease in the after tax cash flow of stock investments. (This is completely ignoring any economic effect like triggering a recession). If the election result increased the probability of them expiring to say 50% than a 7.5% or 1,000 point in DOW is completely justified.