The Affordable Care Act — commonly called Obamacare — has important provisions going into effect on Oct. 1, 2013. And the impact of those provisions on stocks will likely be a mixed bag.
There are some interesting new opportunities for both bearish and bullish investors, but the biggest impact on the market will be due to a shift in investor behavior due to tax changes.
Let’s take a closer look at each of these Obamacare impacts:
Pharmacies and big consumer retailers like Walgreens (WAG), CVS Caremark (CVS) and Walmart (WMT) are likely to see a net benefit from increased business offsetting rising labor costs. And bullish trends in a group like this may last much longer than would normally be expected — but not necessarily due to better fundamental performance.
Managed healthcare companies, on the other hand, seem to have overpriced much of the potential short-term benefits already. In fact, they may be a little overbought at this point as the impact of health exchanges erodes their power with employers.
If this group starts to look a little worse, traders could be very surprised by how quickly selling gets out of control towards the end of the year. After Obamacare goes into effect, the losses in a falling stock could be larger on average than in the past — but not because the firms themselves are doing all that poorly.
The bottom line is one of the biggest impacts Obamacare will have on the market is simply the acceleration and extension of bullish and bearish trends.
On top of that, Obamacare is partially financed by a tax hike that has already gone into effect. Investors who make more than $200,000 per year (or $250,000 for married couples) will be assessed a 3.8% flat tax (in addition to other taxes owed) on investment income that isn’t sheltered or exempt.
This is a big enough issue to change investor behavior in interesting ways. In the past, the average investment was held for around a year in order to take advantage of long-term capital gains treatment. However, the impact of the flat tax may actually create an incentive to hold a position for much longer than a year.
For example, assume that you could sell a position for a $100,000 profit at the end of the year. If we ignore all other taxes, you will owe $3,800 in a flat tax on those gains. But what if you held that position for another year, or two … or ten?
If you held, you would be able to keep that 3.8% at risk and hopefully earn a return each year, rather than it going to the government. That tax penalty is a powerful incentive for long-term investors to hold a winner even longer. We think this could easily push the average selling cycle in winning trades from 56 weeks to 60 to 65 weeks on average.
Longer winning trends seems like a positive impact, but there is a big downside (besides the tax itself) as well. Imagine that you have a losing position this year that seems unlikely to come back in the short-term. How much more motivated are you to use that loser to offset some of your investment income?
This is especially important if you have realized a few big gains, because your outlook for the market has degraded enough to justify taking the hit. Will that kind of selling lead to a bearish feedback-loop for traders?
How to Play It
The bottom line is that externalities like Obamacare tend to increase volatility and accelerate trends. This change could make good years and good stocks better in the long run because investors face a penalty when they sell. However, struggling stocks could really cause some pain when investors use their losses to offset some of their short-term liability.
At this point, it seems that the best defense will be a good offense. Diversification (even for short-term traders) is still the only “free lunch” in the market, and it will likely become much more important as volatility increases.
Identifying runaway bearish trends (especially towards the end of the year) could be a great bearish strategy for put buyers or short traders. Learning to identify those kinds of imbalances like investors do when trading a short-squeeze is a skill we will all likely have to develop to survive and prosper in the future.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.
Our InvestorPlace experts have you covered — click here for more analysis on how to invest under Obamacare.