Return on capital is the measure of one's gain when investing one's hard earned money. Sounds simple enough. I like Apple (AAPL) shares and think they will go higher based on the continuing success of the company's products. I invest money in its shares, ergo it should return x amount of money to me over a period of time.
What happens to your best laid plans when the legislative tone in Washington changes dramatically, injecting uncertainty into business's ability to formulate plans for the next two years? The thesis of this article is to briefly examine the legislative stench that is emanating from Washington, and to give my take on what I am doing with my portfolio going forward.
President Obama has successfully won reelection, and is now faced with making a deal with a divided Congress over the "Fiscal Cliff". I personally have grown quite tired of the media's incessant harping on this issue. While the issues are serious, the powers that be will simply agree to an extension sometime in late November/early December - just in time to save not only Christmas, but Western Civilization. The extension will buy them time to craft a more comprehensive remedy.
One thing I am certain about is that both sides will play a political game of "chicken," trying to force the other to blink before agreeing to an extension. As you can imagine, this type of theatrics will not be looked upon kindly by the stock market. The most interesting "tell" was offered by Obama himself during the third presidential debate, wherein he dismissed the issue simply by saying "it's not going to happen." (He was speaking specifically about sequestration, which would lead to severe cuts to the Defense Department's budget.)
The fiscal cliff, in my opinion, is not what is spooking the markets. The real cause for fear is Obama's pledge to raise taxes on the wealthy. Obama's constant campaigning on the issue of looking for more sources of "revenue" has caused in my opinion an exodus of funds from the market, as witnessed by the above chart. A few examples of changes to tax policy that would negatively impact investors would be raising the capital gains rate and taxing dividends as income.
The capital gains rate for long-term gains (held for more than 1 year) is currently 15%. The unknown factor is to what level they will propose raising the rates to. The uncertainty factor has led many (in my opinion) to begin to liquidate assets to capture this attractive rate. The rush of investors to take advantage of these rates before the year ends will add consistent downward pressure on the market. I have noticed that with every attempt at a rally since Election Day has been met with persistent selling. The markets from a technical perspective are below both their 50- and 200-day moving averages. Not exactly the most encouraging setup.
The second possible factor would be a change in the way dividends are treated. A change in rates from the current 15% rate on qualified dividends to your ordinary rate could very well translate into a doubling of rates for most taxpayers. The loss of additional income may cause a tip in the scales towards municipal bonds due to their state and local tax exemptions. The investor may decide to forgo market risk for what would be a minimal jump in income. A scenario such as this will cause further downside pressure on share prices as investors switch asset classes.
In my personal portfolio, I have liquidated all holdings except BP Prudhoe Bay Royalty Trust (BPT), IBM (IBM), Intel (INTC) and Bristol-Myers Squibb (BMY). All other companies that I have written about were liquidated on November 7th and 8th. I will provide a brief synopsis below as to why I have decided to continue holding the above mentioned companies. (To read my original theses on the above mentioned companies, click on the name which should link you directly to the article.)
BP Prudhoe Bay Royalty Trust is an oil trust with a long history of paying out a significant quarterly dividend. The current yield is above 10%, which makes it quite tempting in today's depressed interest rate environment. My thinking here is to collect the dividend and to reinvest it quarterly. The reinvesting of the dividend will allow me to compound at a steady rate. I anticipate the price of oil will remain elevated for the foreseeable future, allowing me to collect significant dividends in the interim. The shares can lose value if the pipeline is shut down for maintenance (which is what happened last quarter) or for any other reason. I am comfortable with the risks and will continue holding.
IBM is being held due to its annuity like revenue stream and management's steadfast commitment to shrinking shares outstanding. As the company continues to buy back large amounts of shares, this allows earnings to grow at a steadier rate and raises the value of the remaining shares held by shareholders. I am comfortable with the company and appreciate how it views its stakeholders.
Intel is being held for the dividend plus as a speculation in the semiconductor space. I believe reports of its imminent demise are highly exaggerated. The idea that INTC won't be able to compete in the mobile space is just silly. With management aggressively targeting growth in the mobile and tablet market, I expect INTC to gain share at a rapid rate.
Bristol-Myers Squibb is being held due to its pipeline and management's commitment to taking care of shareholders. BMY has some new products that the sales force is starting to aggressively push along with future products in the pipeline. I am comfortable owning its shares here and will be reinvesting dividends.
Going forward, as both parties wrangle over the future path of taxes, I expect the uncertainty to loom large over the markets. I anticipate the uncertainty will cause business to hold back on hiring and expansion plans as the details are sorted out. I am content to remain on the sidelines and will jump in temporarily on any small rally. The current environment is a trading environment, not a buy and hold type of environment. The best course of action is to be a nimble trader while keeping an ample amount of cash handy.