As the U.S. fiscal cliff inches closer, more economists say government spending cuts and tax increases will take the U.S. economy into a severe recession. Some are predicting severe losses, with two million expected job losses and a contraction in U.S. gross domestic product (GDP). (Source: Reuters, August 22, 2012.)
Sadly, there is more to it than just an economic slowdown. The tax increase in the fiscal cliff includes a higher dividends tax. The dividends tax rate could increase up to 43.4% from its current 15.0% if Congress doesn’t take some serious action before the end of the year. (Source: Business Insider, October 25, 2012.)
If the fiscal cliff is allowed to happened, for each dollar of dividends you get, you will be paying $0.43 of tax compared to $0.15 now. If you thought you could protect your portfolio by buying stocks that paid dividends during a recession and weather the storm, you could be in for trouble.
My concern is that the fear of a dividends tax increase and the uncertainty about the government’s ability to make a decision on time will lead to an extensive selloff in S&P 500 stocks prior to year-end. The reasons are simple: the stocks that pay dividends could become unattractive to investors, as they have to pay more taxes on them.
How much could the S&P 500 be affected if the fiscal cliff happens? Well, so far this year, 403 companies, or about 81.0% of them, in the S&P 500 index are giving out dividends. (Source: Standards and Poor’s, September 2012.) If all of a sudden these stocks become a burden to hold, you can bet the S&P 500 will be going lower.
Will Congress come to a decision before the end of this year? It all depends on what happens tomorrow in the U.S. election.
What’s certainly true is that if this absurd tax increase does take place, investors may be saying goodbye to the dividends that provide much of their income today. If you thought the war on your portfolio was over, you were wrong.
Where the Market Stands; Where It’s Headed:
With the elections out of the way in only a day’s time, and regardless of the outcome, the markets are in for a difficult ride for the remainder of 2013.
What He Said:
“The Real Threat to the Economy: U.S. retail sales are falling, the producer price index is crashing, house prices, car prices are all falling—and no one is talking about deflation but me. Fed governors are still talking about inflation—they’ve got it wrong. There’s no need for me to get into the dangers of deflation as I’ve written about them (many times) before. Let’s just put it this way: Deflation is about the worst economic state a country will experience. The risks to the U.S. economy in 2007 are greater than I’ve seen in years.” Michael Lombardi in Profit Confidential, November 15, 2006. Michael was one of the first to warn of deflation. By late 2008, world economies were embedded in what was their worst state of deflation since the Great Depression.