Fiscal Cliff: With Crisis Averted For Now, Investors Can Briefly Rejoice

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The House of Representatives late yesterday evening approved the fiscal cliff deal already passed in the Senate, meaning President Obama will soon sign the legislation into law. “Everybody worked very hard on this,” Obama said in nationally televised remarks after the vote. “Under this law 98% of Americans, and 97% of small businesses will not see their income taxes go up.”

Investors should take a moment to take a long breath. Relief was clearly evident in this morning’s market. Stocks pointed sharply higher. Dow Jones industrial futures gained 1.3%, 168 points, and Nasdaq composite futures added 2%, 53.5 points.

This follows a marathon 48-hour span in Washington, D.C., in which the odds that a deal would come seemed greatly in flux, pols managed to construct a bill that largely delayed some of the largest issues that confronts us. The legislation passed by a healthy margin in the House, by 50 extra votes that included ballots by House Speaker John Boehner and former Republican Vice Presidential candidate Paul Ryan.

Here is what the bill does:

  • For American families with income more than $450,000 and individuals making more than $400,000, tax rates increase to Clinton Administration levels. Below those wage levels, income taxes will remain unchanged. (Basically, 98% of Bush Tax Cuts will become permanent. Under the Bush Administration, the breaks expired after a decade.)
  • The wealthiest, those making $450,000/$400,000, will pay 20% on capital gains and dividends. Everyone else will pay 15%. Estate tax will be 40% for the wealthy.
  • Several tax breaks for middle class and lower income Americans were extended for five years: the Earned Income Tax Credit, the Child Tax Credit and the American Opportunity Tax Credit.
  • Several deductions used by wealthier Americans will be reimposed: the Personal Exemption Phaseout will be at $250,000 and the itemized deduction limitation, the so-called Pease provision,  kicks in at $300,000.
  • The Alternative Minimum Tax will be adjusted for inflation.
  • Medicare cuts will not happen. Temporary business tax breaks will exist for another year, as will federal benefits for those unemployed longer than 26 weeks. A nine-month farm bill will avoid milk doubling in price.
  • Bill adds $4 trillion to the U.S. deficit over the next decade, according to the CBO.
  • Tax increases will raise around $600 billion over the next decade. Significantly, this is less than President Obama originally wanted ($1.4 trillion), and even less than House Speaker John Boehner proposed ($1 trillion).
  • Raises taxes on 77% of Americans. Joe Average will pay about $700 more in taxes. Mostly this is because the payroll tax holiday expires.

But the bill does not accomplish everything. Not by a long shot. By striking only an eleventh-hour decision, pols have set up a continual series of debates and fights in coming weeks that will roil markets. “This law is just one step in broader effort,” Obama said. The president had attempted to address other prickly issues, but found ”there was just not enough time or support for that in a lame duck session of Congress.”

Here is what the bill does not do:

  • Extend the $16.4 trillion debt ceiling. The U.S. reached its statutorily mandated debt level on New Year’s Eve day. The Treasury Department will now use a series of creative accounting measures to keep the nation operating. It will buy us around two months. After that, the nation faces a governmental shutdown.
  • Decide what to do about the massive budget cuts to defense spending and other government programs. The sequester will be delayed for two months.

That’s a list that will tax pols and make investors uneasy. (See Eight Ways To Protect Your Finances From A Fiscal Cliff Fall Here.) Do not revel too greatly over this legislation. The joy may be short lived. “The latest agreement removes a good portion of the immediate fiscal tightening threat, but does nothing to resolve these longer-term challenges,” says Citi economist Steven Wieting. “The next potential showdown over the debt ceiling and sequestration may revive such efforts.”

Already, though, investors made their relief apparent with that early morning rally that began in overseas markets well before U.S. trading started. The Euro Stoxx 50 climbed by 2.5% to 2,702.13. The FTSE 100 added 2% to 6,013.73. Asian markets told a similar story. The Shanghai composite went up 16% to 2,269.13, and the Hang Sheng index increased 2.9% to 23,311.98.

When U.S. stocks begin to trade, keep an eye on bellwether stocks—companies with a large, encompassing business. These are businesses like Apple and FedEx. Also monitor on whether investors flee to safe stocks like Proctor & Gamble, PepsiCo and Walt Disney—companies that can likely withstand troubled economic times. If a rally extends beyond these names, that will suggest a broad surge, extending optimism from earlier this week. On Monday, the Dow Jones industrial average experienced a triple-digit gain, rallying 1.6%, 166.03 points, to 13,104.04.

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