Stock Market Analysis Approaching 2013

There are valid reasons to be both bullish and bearish on the stock market.  There are a lot of things going on in the financial and political world.  Some of these things will be good for stocks and some will be bad.  It will just be a question of what wins out.

After Obama's re-election, the stock market tanked for two days.  It was blamed on the looming fiscal cliff, but that has been known about for a long time.  If anything, Obama's re-election solidified that at least part of the fiscal cliff will not be avoided.

If nothing changes between now and December 31, tax rates scheduled to go up will go up.  The Social Security payroll tax will go back up from 4.2% to 6.2%.  Income tax rates will go up across the board.  An additional Medicare tax will kick in from Obamacare on high income earners.  And probably the most important to the stock market, capital gains tax rates will go up.

The capital gains rate will go up to 20% on January 1 for some people (the ones most likely to own stocks).  Not only that, but an additional Medicare tax of 3.8% will also apply to capital gains.  This is from Obamacare.  It would not surprise me if these tax rates are the reason we saw stocks go way down right after Obama was re-elected.  Stock owners are guessing that the capital gains rate will go up as scheduled in January.

This is why stocks like Apple, which have done well, took a big hit.  It makes sense.  Someone who bought Apple stock is probably sitting on big gains.  They are better off selling before the year is over and paying the lower capital gains rate.  This is a good reason to be bearish on stocks until we hit 2013.

There is a very good reason to be bullish on stocks too, despite the unfriendly taxes.  It is Ben Bernanke and QE3 (or what some are calling QE Infinity).  Obama's re-election solidifies more government spending, more government debt, and more money creation (not that it would have been different under Romney).  While monetary inflation is bad long-term economic policy, it can be good for stocks.  Stocks are not dollar-denominated like bonds or a money market fund.  While stock prices may not go up in real terms, they will probably go up in nominal terms if there is enough money creation.

While I expect to see a continuing roller coaster over the next few months, I think the direction of the stock market will ultimately depend on the economy and whether we fall into another recession (if the last one ever actually ended).  The problem is that the stock market will be more of a pre-cursor to the economy than the other way around.  If we fall into recession, I expect stocks to lead the way.  On the other hand, if we hit an artificial boom caused by the easy money policies of the Fed, then I would also expect stocks to lead the way up.  If this happens, it will be hard to say how long the artificial boom can last before the final bust.

At this point, I wouldn't be betting heavily for or against stocks.  It is ok to have stocks if it is part of your permanent portfolio.  Otherwise, they seem too risky right now, particularly with capital gains tax rates set to go up.