The New Year began with a bang. The S&P 500 rose a stunning 4.57% last week (including New Year's Eve Day). The catalyst was a new tax package that took shape during a partial leap off the "fiscal cliff" on New Year's Day - when the stock market was fortunately closed. Due to the long-running fear of the impending cliff, institutions held mountains of cash on the sidelines going into 2013, so a relief rally quickly ensued, as some of that idle cash returned into play, lifting the market last week.
The Emergency Cliff Deal Seems Relatively Favorable for Investors
It could have been worse. Investors exhaled a sigh of relief after the McConnell-Biden tax hike compromise plan only raised taxes on dividend and long-term capital gains for high-income earners to 20% (from 15%), rather than the President's plan for a top 43.4% tax rate on investment income. In addition, couples making over $250,000 per year will pay 23.8% on capital gains and dividends, due to the special 3.8% surtax to help pay for the Affordable Care Act (Obamacare). Also, taxes on ordinary income will be raised from 35% to 39.6% for couples making more than $450,000, or for single taxpayers earning over $400,000.
These new tax rates overwhelmingly passed the Senate in an 89-8 vote and passed the House by a vote of 257 to 167. However, the House of Representatives is still fuming over the McConnell-Biden plan because it includes no spending cuts. Earlier in December, the House rejected "Plan B," which imposed income tax increases on families earning over $1 million simply because "Plan B" imposed no spending cuts.
Although the President lobbied to "save the middle class," he allowed a 2% payroll tax rise for Medicare and Social Security withholding taxes, and a 2.9% increase for those making over $250,000 per year. This means that 77% of all households will now pay higher taxes in 2013 than in 2012. Most consumers will have less take-home pay in January, while facing steep credit card bills to pay for their holiday shopping.
Even though Washington addressed the tax cliff question in the nick of time, they ignored two other major financial challenges - the debt ceiling and spending cuts. While our politicians were arguing about our tax rates, the U.S. government ran out of money last Monday, when the federal government bumped against its $16.4 trillion deficit ceiling (which was not raised due to ongoing Congressional gridlock).
It looks like the House will become very assertive in demanding spending cuts in exchange for debt ceiling relief. In the upcoming debt-ceiling debate, House Speaker John Boehner has signaled he will forego any private negotiations with President Obama, since the President recently used his surrogates, Vice President Joe Biden and Senate Majority Leader Harry Reid, to bypass dealing with the Speaker.
Stat of the Week: 168,000 to 215,000 Private Sector Jobs Added in December
Last week's economic news was mostly positive. On Thursday, the ADP survey of private sector payrolls revealed that U.S. businesses added a net 215,000 private sector payroll jobs last month, of which 187,000 (87%) were in the service professions and 28,000 (13%) were in manufacturing.
On Friday, the Labor Department announced that 168,000 new private-sector payroll jobs were added in December. Government shed 13,000 workers, so our net gain was 155,000 new jobs. Even better, the November payroll report was revised up to 161,000 new jobs, up from 146,000 in the initial report.
Our job growth rate may increase in 2013 if you believe the results of last Friday's Institute of Supply Management "ISM" surveys, which were all bullish: The ISM service sector index rose to a healthy 56.1 in December, the highest reading since February, up from 54.7 in November, as 13 of 18 service categories gained ground last month. What's more, ISM's new orders index rose to 59.3 in December, up from 58.1 in November, while the ISM employment index surged to 56.3, up from 50.3 in November.
The much-maligned manufacturing sector is also seeing a renaissance. On Wednesday, ISM reported that their manufacturing index rose to 50.7 in December, up from 49.5 in November, and slightly better than economists' consensus expectation of 50.5. In addition, Markit's U.S. purchasing managers index "PMI" rose to a seven-month high of 54 in December, so the manufacturing sector is starting to claw back.
Turning to Europe, Markit reported on Friday that its euro-zone PMI rose to 47.2 in December, a nine-month high. Even though any reading below 50 signals a contraction, mighty Germany's PMI rose to 50.3 in December, which is a good sign for the euro-zone. In Asia, China's official PMI rose to 50.6 in November, a 7-month high, while the HSBC PMI for China rose to 51.5 in December, a 19-month high. As China rebounds, global GDP growth is expected to steadily improve, which bodes well for 2013.
Averting the Cliff May Spur a Return to "Business as Usual" in 2013
When you put together rising ISM and PMI numbers, a healthy (160,000+) series of new private-sector jobs per month, along with some clarity about tax rates, including moderate increases in investment tax rates, the business community seems poised to have a better 2013 than originally feared. In the last half of 2012, business spending contracted sharply, so with the tax-rate uncertainty now over, businesses can get back to planning and spending. Unfortunately, however, consumers are now loaded with more credit card debt, while facing smaller paychecks, so we will have to monitor consumer sentiment closely.
Perhaps America's new and positive economic numbers will convince the Fed that it may not need to stimulate the economy "forever," via QE-3 and Operation Twist. According to the Federal Open Market Committee (FOMC) minutes released last Thursday, the Fed may end its $85 billion per month mortgage-backed bond and Treasury security buying program (QE-3 and Operation Twist) by the end of 2013. In fact, several FOMC members want to stop or slow "QE" immediately, while a few other FOMC members said QE could continue through the end of the year, whether or not the unemployment rate drops to 6.5%. Either way, internal resistance to the Fed's seemingly eternal money-pumping policies seems to be rising.
In the meantime, the fourth quarter earnings announcement season will begin soon. The consensus earnings estimate for the S&P 500 is only 3.1% growth in the fourth quarter and a disappointing 1.5% for the first quarter of 2013, so the market seems to expect an anemic earnings environment in early 2013. But what if we return to "business as usual" in 2013? Perhaps the market would greet that news with a strong rally.
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