The fiscal cliff that is approaching could surprise some investors if Congress does not act before the first of January. Many people are confused as to what will happen, when and if, the country goes over the "cliff". A lot of investors are making plans now to protect their paychecks and wealth from the unknown, which is extremely hard to do:
It is known in Washington as the "fiscal cliff." But policy and economic analysts projecting its complicated and wide-ranging potential impact said the term "fiscal hill" or "fiscal slope" might be more apt: the effect would be powerful but gradual, and in some cases, reversible.
By reversible, the author goes on to say that the initial impact will be immediate changes in your withholding beginning in January. However, this can easily be reversed if Congress changes the tax code. Several articles mention that most families will have enough savings to get through January with less take home pay. But the first thing that everyone needs to do is consult with their accountant to find out what the tax changes might mean for their particular situation. Including: if their job is safe. Due to cuts in government spending which will take billions of dollars away from agency budgets, there may be 2.14 million jobs lost if we go over the cliff.
What we know right now is that taxes will go up for almost everyone, unless Congress acts before the deadline. However a lot of analysts think that they will not act in time. Both Democrats and Republicans have said that it will be easier to negotiate after the "fall", and the election. The public pressure will be intense at that time, making lawmakers more receptive to finding a fast solution. So find out how much you might need, and prepare for it now. Even though the middle income taxpayers will be hurt the least (some estimate between $755 to $3500 per year),
Millionaires, by contrast, see their marginal rates of wages go from 38 percent to 44.2 percent. And the poor see rates go way up as well. Households making between $10-20,000 a year see marginal rates on wages go from 16.4 percent to 20 percent. Indeed, the marginal tax rate hike for poor people, as a percent of their previous tax rate, is enormous.
And those "poor" people will be hit with a double whammy because the government spending that they depend on (food stamps, the Earned Income Tax Credit, etc) will be phased out at the same time. Many elderly and retired people will fall in this category which will cause a major drop in their spending. This in turn affects many areas of the economy. A lot of analysts agree that the government spending has to stop, however most feel that dramatic cuts like this will dampen the recovery.
How will all of this affect the stock market? There are several possibilities. A lot of investors will (or already did) sell their holdings before the end of the year, to take advantage of the lower capital gains taxes. Most will (or already did) get back into the market with a new higher beginning cost basis. And many will liquidate some investments to have extra cash on hand to offset the potentially higher payroll withholding. The problem with this is that so many people wait until the very end. They are hoping to get the highest possible price for their investments. Because, who knows where the market will be in two months? If everyone sells, the market will be lower at the end of December. And then if we do go over the cliff, there will be even more people, who were completely caught off guard, selling in January to help make ends meet. Especially if they are about to lose their job. Many of the jobs that could be lost are those indirectly tied to government agencies.
Remember, there are no guarantees that Congress will reach an agreement right away. The upside to that, however, will be more investors trying to shelter their 2013 income in 401-k's and IRA's, which should make the market start jumping next Spring, provided that we do not go into a recession. So where should you put your money right now?
First of all, I would stay away from companies that rely on government contracts. Also retail stocks will suffer. I wrote an article earlier in the year about so many people owning old cars, and the probability that they will have to replace them soon. This combined with the fiscal cliff will cut into a consumer's spending at the mall. However, the car industry may remain stable due to the replacement factor.
Tech stocks always get slammed during any type of a crisis, however they can be the most lucrative in the end. Consumers still need their gadgets. A smart phone, tablet and laptop are now considered necessities for a lot of people. Those devices are needed in the workplace, and provide a relatively "cheap" form of entertainment. Four very popular "gadget" companies are shown on the chart below. It compares them with each other and the DOW and NASDAQ over the last two years:
Apple (NASDAQ:AAPL) is the most popular, and produces products that have almost a cult following. I am really surprised that the company has remained so competitive, and lowered prices when necessary. Many would probably go without food before they would give up their iAnything. As you can see, in 2011 the stock followed the two indices, and then broke ahead in 2012. A couple of weeks ago the share price began to fall due to rioting problems in its Chinese factories, and supply issues due to the iPhone 5 scratching problems. This will probably have a negative impact on next quarter's revenue unless Apple can quickly turn the problem around. Some analysts, such as this from Wall Stree Journal, think that Apple has not hit bottom yet, and it may fall more. But even if it does, the stock has proven to be a safe haven during economic downturns.
Microsoft (NASDAQ:MSFT) is another popular tech stock. Its purple line is barely discernible on the chart, as it has exactly followed both indices over the last two years. Even though it has not jumped ahead, it has proven itself to be another safe haven during the slump the economy has been in. And with the new Surface Tablet, and Windows 8 software due to come out this Fall, it may make a sudden upward move. Watch for the publics reaction to these products, because there are early indications that they will be very lucrative and add unexpected revenue to the next quarter.
Nokia (NYSE:NOK) has disappointed investors for the last two years. As you can see its red line has been declining compared to the other companies, the DOW, and NASDAQ. However, it has one last shot at redemption with its soon to be released Lumia 920 Windows Phone 8. Everything depends on how this phone is accepted by consumers. Because of the fact that it will interact with other Windows 8 devices, it should be popular with the "Office Crowd". And Microsoft seems determined to keep Nokia afloat. This one is definitely a long shot, but the upside could be substantial.
Sirius XM (NASDAQ:SIRI) is a stock that has been beating the two indices decisively for the last several years. And in 2011 it beat Apple. The two are currently tied at (up) 100% on the chart. As I mentioned, new car sales, that are due to the replacements of older models will remain high because of pure necessity. Sirius CEO Mel Karmazin mentioned that the Satellite Radio Giant will continue to flourish due to historically high auto sales which should continue for several years. This has pushed subscriptions to the service historically high also. New sub guidance for 2012 net additions has just been raised to 1.8 million. And with new content added all the time, many of the radio buffs listen on portable Sirius devices and smartphones at home and on the go. Exceptional earnings combined with planned stock buybacks, which will return equity to shareholders, will keep Sirius on an upward path.
Earnings for all of these companies are due out in the next two weeks. Word on the street is that any company that does not deliver a stunning upside to last year will be punished. Many analysts are taking a sudden bearish turn because investors are getting "cold feet". Here is an excerpt from a typical Gloom and Doom article on Sunday:
"Caution is definitely the operative word as Europe and China look to continue dragging on earnings," said Michael Loewengart, director of investment strategy at E-Trade Financial in New York. "The overall tone is so pessimistic that we may see some upside surprises, but we could still suffer considerable losses if the news is bad."
Profits of S&P 500 (.SPX) companies are seen dropping 3 percent this quarter from a year ago, the first decline in three years, hurt by China's slowing growth and Europe's debt crisis, which recently prompted the International Monetary Fund to cut its 2012 economic growth outlook.
And this bearish attitude may continue over the next couple of months until we go over the cliff. So my advice is to immediately see what your needs will be, worst case scenario, and make the necessary changes sooner rather than later. Everyone will have different circumstances, so don't make decisions based on what your friends plan on doing. Talk to an investment professional. Because if you take action and invest in companies that will weather economic downturns, the fiscal cliff will only be a little slope for you. And if the gloomy earnings reports are true, you can take advantage, and buy the dips.
Disclosure: I am long SIRI, NOK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.