A lot of the information that’s being tossed around about higher capital gains taxes, higher income taxes and how the government is going to handle the fiscal cliff is making investors nervous and confused. On the markets front, selling ahead of the news (a bad idea if there ever was one) has created some bargains for managers who are in a shopping mood and have cash to spend.
Investors seem to be selling into the end of the year on the supposition that they should take advantage of 15% capital gains taxes today because the rate is going higher tomorrow. The trouble is:
- We don’t know how much higher
- We don’t know whether the new tax rate, whatever it is, will stick beyond the next election cycle
- And on an individual level, you need to have some idea of the expected growth rate, going forward, for the investment you’re thinking of realizing gains on. And yes, there’s also the possibility of getting pushed into paying the alternative minimum tax if you take too many gains in 2012.
Suffice it to say that there’s no better tax advice than that you can give yourself, or that is given to you by the accountant who knows your personal financial situation best.
Also, you might be interested to learn that the fiscal cliff may be less precipitous than thought. Recent data show that the federal government has been applying the spending brakes faster than any time since World War II. Over the past three years, the federal deficit has been falling fast — really fast, according to the Office of Management & Budget, which looks at deficit spending relative to GDP.
From fiscal 2009 to fiscal 2012, the deficit as a percentage of GDP shrank from 10.1% to 7%. Partially, this reflects the end of TARP and other stimulus measures, but it also reflects lowered spending on defense (particularly the war in Afghanistan) and slower growth in Medicare outlays.
By the way, absolutely no correlation exists between higher taxes and lower stock prices. We’re currently subject to some of the lowest tax rates in history, and yet during periods of much, much higher tax rates, stocks put on a pretty good show.
From the end of 1986 through the end of 1996, the capital gains tax rate was 28% and the income tax rate on both dividends and regular income moved from 28% to 31% to 39.6%. Still, over that period, the S&P 500 returned 15% annually. And remember, during that period we experienced the 1987 Black Monday crash and its aftermath as well.
Could the market rally at some point in the year’s closing weeks? According to one study looking at the trading behavior of insiders — by which I mean corporate chieftains who must report all their transactions in their companies’ stocks — bullishness has reached a fairly high level. Insiders are more than four times as optimistic about their companies’ shares as they were just two months ago.
Credit that to the market’s fall and growing optimism that the fiscal cliff will finally be dealt with before year-end.
Dan Wiener is editor of The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.