From the desk of Peter Blatt
October 19, 2012
In 2008, the S&P 500 (an index of the top 500 stocks) dropped 39.79 percent. Thus, if you had $100,000 in the stock market on January 1, 2008 until December 31, 2008 you would end the year with $60,210. So where did the $39,790 loss go?
Have you recovered it yet? Will you keep it if you did? What happens if we have another market correction like we did in 2008?
In 2008, we had a 3 standard deviation decline. This is supposed to happen approximately every 20 years. Standard deviation, as used by investors, is a statistical measure of the historical volatility of an index, stock, mutual fund or portfolio, usually computed from a minimum of 36 monthly returns.
More specifically, it is a measure of the extent to which numbers deviate from their average. It also quantifies the uncertainty in a random variable, such as historical stock market returns. To be precise, a standard deviation is the root-mean-square deviation of values from their average, or the square root of the variance.
Do we believe that our economy is in a better shape than it was in 2008?
On the negative side, we have over a 16 trillion dollar deficit (up 1.5 trillion since 2008); higher unemployment (perhaps 7.8%); economic crisis in Europe; overall corporate earnings down; higher standards of lending (harder to get loans); political election, and other items. On the positive side, we have had QE3 (large amounts of capital going into the economy); increase in housing prices; some corporate job creation (GM, etc.); investor sentiment improving (per polls), and other items. Even if the positive outweighs the negative, what could tip the scales to a large market decline another 2008?
WHAT COULD CAUSE ANOTHER 2008? The end of the Bush Tax Cuts.
The Congressional Budget Office reported on August 22, 2012 that the economic consequences of the U.S. going over the "fiscal cliff" in 2013 will be more dire than originally thought. Specifically, if $600 billion in tax hikes and spending cuts scheduled to hit in January are not averted, then the country will suffer a substantial recession, with unemployment rising above 9% and a 2.9% contraction in gross domestic product in the first half of 2013.
FISCAL CLIFF OVERVIEW
The events include the expiration of the Bush era tax cuts, the payroll tax cut and other important tax-relief provisions. They also include the first installment of the $1.2 trillion across-the-board cuts of domestic and defense programs required under last summer's bipartisan deficit reduction agreement.
One of the major Bush Tax cut is the reduction of the capital gains rates. Currently, the maximum federal rate on long-term capital gains and dividends is only 15%. Starting next year, the maximum rate on long-term gains is scheduled to increase to 20% (or 18% on gains from assets acquired after Dec. 31, 2000, and held for over five years), and the maximum rate on dividends will rise to 39.6%. This could cause a large per end of year sell off of investments.
For example, if you own Apple stock at $700 per share and you paid, $500 per share (you are up $200 per share) you would try to sell it prior to your capital gains tax rates jumping over 24.6%. Now imagine ever investor is faces this same jump in tax rates on January 1, 2013. There would be ramped sell-offs right before the end of the year. We would see prices of all largely held stocks drop. Kind of like what happened in 2008. This is a ramped sell-off due to a crisis that has nothing to do with the actual investment. Could this become another housing crisis in disguise?
So how to do we prepare for the worst and still make money in our investments? The answer is reduce your risk, while still participating in the market. Move to a more conservative approach of investing. One that is more active, that also has a good track record in market declines.
Act now. But beware, markets react prior to the end. If there is going to be a fall it probably will be partially felt prior to the end of the year. It is your choice, be informed.
Until next time,