Over the River and Through the Woods . . . and Over the Cliff We Go . . . .
There is no realistic possibility of a "cliff" deal getting done before Jan. 1 because Obama has no incentive whatsover to do a deal before then. Right now Obama needs the Republicans to get tax rates on the 1% up. But all Obama needs to do is to do nothing and he gets what he wants without the Republicans..And he gets a "bonus": higher tax rates on capital gains and dividends.
Come Jan. 2, the Republicans need Obama to get the rates on the 1% back down and restore the other tax breaks for investors.Of course, Obama still needs the Republicans to get the middle-class tax breaks he wants. But, after Jan. 2, when rates on capital gains, dividends and the 1% are pushed up by operation of law, do you really think that the Republicans will block middle-class tax relief to protect the 1% or tax breaks for Wall Street? It would be political suicide to sacrifice Main Street for Wall Street. Obama has the Republicans outfoxed and in a political trick bag--largely of their own making or, should I say, of Grover Norquist's making.
With both sides whining and blaming the other for lack of progress in the negoitaions, no face-to-face meetings scheduled, Congress adjourning for the holidays on the 14th and Obama leaving for his holiday vacation on the 17th, a deal ain't happening by Jan. 1, particularly given the alteration in the balance of negotiating power that occurs on January 2 thru nothing more than the passage of time.
So what does this mean for investors? It puts enormous pressure on those holding big capital gains to sell this month and realize them this year. Someone in that position could bet that a deal restoring the tax breaks for capital gains eventually will be made.. However, I belive there is a very realistic possibility that "the ultimate deal" could leave the increase in the capital gains rate in place as part of the price for a crude, "face-saving" compromise that lowers the top income tax rate to say 37%--higher than the current rate but lower than the pre-Bush tax -cut rate. I could be wrong about that. But, given the politically instable environment we are in, are investors with big capital gains likely to bet the farm that favorable treatment of capital gains will be restored post January 1? I don't think so. The "safe" play is to sell now, realize the gains, and buy back your position after the thirty-day stay-away period mandated by the income tax code if-and this is also a big if--you can handle the ensuing 2012 tax liability on those capital gains.
Once this week passes with no progress having been made on a "cliff" deal-- and I expect none since Obama has no good reason to make a deal by Jan.1--I believe the markets will come under selling pressure from investors claiming their capital gains. We could have an Apple-like swoon in the market generally.
But there are offsetting factors: the seasonals favor a "Santa" rally; the Fed remains friendly and may give the market another QE "shot-in-the-arm" next week; and the short-term trend at least appears to be bullish even in the face of the lack of progress on a "cliff" deal. Indeed, the market is looking a little "overbought" to me on a technical basis.
Could break either way. Stay flexible. A follower and not a leader be.