11/21/12   Fiscal Cliff Primer

Editor’s Corner

Ron Rowland

What is this Fiscal Cliff that everyone is talking about?  That’s a question we hear quite often.  Today, we’ll take a stab at providing a concise answer.  For those of you that remember Father Guido Sarducci’s Five Minute University from Saturday Night Live in the late 1970s, he would probably teach it as “Fiscal Cliff = More Taxes + Spending Cuts.  Next subject.”

The word “fiscal” is defined as “of or relating to government expenditures, revenues, and debt.”  The U.S. government does not include the Federal Reserve, so Mr. Bernanke and the Fed can do nothing about this cliff except offer suggestions.  When the government talks of increasing revenue, what they really mean is increasing your taxes.

The Fiscal Cliff is indeed a combination of tax increases and government spending cuts.  They are all scheduled to take effect at about the same time, late December and early January, hence the “cliff” part of the phrase.

Additionally, the debt ceiling will likely be hit in the first two months of 2013.  The concern is that all of these items occurring simultaneously will push the currently fragile U.S. economy into a deep recession.  With help from the Council on Foreign Relations, we will now summarize the various tax and spending items that are part of the fiscal cliff.

Tax Increases

Expiration of Bush Tax Cuts: The 2001, 2003, and 2010 tax cuts are set to expire December 31.  The top income tax rate will go from 35% to 39.6%, and millions more citizens will pay the AMT (alternative minimum tax).  The current reduced tax rates on dividends and capital gains are also part of this group and set to expire.  (Note: even though the 2010 tax cuts came while President Obama was in the oval office, they are usually part of what is referred to as the Bush-era tax cuts).

Obamacare Taxes:  Officially known as the Affordable Care Act Taxes, the 3.8% Medicare surtax on investment income for high earners and a 2.3% tax on medical devices go into effect in 2013.

Expiration of Payroll Tax Cut: The Social Security payroll tax holiday expires December 31, raising the rate by 2% (from 4.2% to 6.2%).

Expiration of Other Tax Provisions:  Several other tax cuts and credits, such as the Research and Experimentation tax credit, will expire on December 31.

Spending Cuts

Sequestering:  The Budget Control Act of 2011 contains automatic spending cuts (“sequester”) that begin January 2.  Half of the cuts are to be from the 30% of the defense budget identified as being non-mandatory.  The other half will come from non-defense items.

Expiration of Extended Unemployment Benefits: Unemployed workers will be dependent upon the maximum of 26 weeks of state benefits only; federal benefits extending that maximum will no longer be available after December 31.

Doc Fix:  The payment rates from Medicare to doctors will decrease by nearly 30% on December 31.

Debt Ceiling

The maximum amount the U.S. can borrow (“debt ceiling”) is set at $16.39 trillion.  The U.S. Treasury expects to hit this limit in early 2013, likely before the end of February.  As you probably remember, congressional bickering over this limit in August 2011 nearly led to a default on U.S. Treasury debt payments and contributed to the shocking downgrade of U.S. credit.

Status

The time to resolve all the items above is quickly shrinking.  Congress is working within a “Lame Duck” session, the Thanksgiving holiday is upon us, and Congress is scheduled to adjourn on December 14.  In other words, there is only about three weeks left.  The market rallied the past four days on word that negotiations were making progress.  Let’s hope both sides of the aisle can put politics aside and do what is best for our country.

Investor Heat Map: 11/21/12

Sectors

Consumer Discretionary moved up one notch to take over the top position.  Helped by a strong showing in home construction and the leisure industry, this sector is the only one in the green today.  Last week’s only positively trending sector, Industrials, flipped to red this week and finds itself bunched up in a three-way tie for second place.  Financials and Health Care are the other two locked in that battle.  Consumer Staples and Materials round out the relatively stronger group of sectors, as the momentum scores start to drop dramatically for the bottom four.  Oil prices have been volatile on Mid-East tensions, but Energy related equities seem to be holding on to their gains and are poised to move up the rankings.  Telecom was the worst performing sector the past week and remains mired in a negative trend.  Technology managed to put together a nice bounce, which allowed it to move up and out of last place.  The bottom slot now belongs to Utilities, proving that the “defensive” label does not come with any guarantees.

Styles

Mid Caps continue to hold the upper three positions in our Style rankings.  Their relative order is the same as last week with Mid Cap Value providing the overall leadership while Blend and Growth are close behind.  However, they are all still registering negative momentum readings, so their relative “strength” is more of the “least weak” variety.  The next three positions are also filled by the same categories as a week ago.  Namely, the three Large Caps.  They also happen to be arranged in the same order as the Mid Caps with Value on top, followed by Blend and Growth.  Mega Cap moved up two spots to be closer to its Large Cap cousins. That leaves the Small Caps trailing behind.  Micro Cap remains at the very bottom and is the only Style category posting a decline in its momentum score this week.

Global

Our Global rankings show more improvement over the last week than either our Sector or Style rankings.  The quantity of positively trending regions doubled from three to six.  China sits on top again and has increased its margin over second place Pacific ex-Japan.  There has been some shuffling in the next few positions with Europe moving up to third and EAFE following in fourth.  Moody’s downgrade of France’s debt from AAA didn’t seem to have a negative effect on France or any of its neighbors.  Emerging Markets fell two spots but managed to maintain a positive trend reading.  The big mover this week is Japan.  Not only did it turn in the best absolute performance of all 32 equity categories, but it also jumped four spots in the rankings.  Two weeks ago, Japan was in last place and today is in sixth.  The yen’s decline of the past two months accelerated last week.  Typically, a falling currency acts as a headwind for international funds.  In the case of Japan, a weaker yen helps its export oriented economy, and the increase in Japanese stock prices more than offsets the negative currency translations.  North America continues to slide down the rankings with Canada dropping from sixth to ninth and the U.S. dropping another notch to tenth.  With Latin America maintaining its hold on last place, the three Western Hemisphere categories now constitute the bottom.

 

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“What zip-code is the Fiscal Cliff in? I want to build a bar with an observation deck.”

Anonymous


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