Insights & Advice

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All or Nothing

The beat goes on with dizzying regularity: big down days, followed by big up days with nary a reason for either. Hedge funds, flash traders and computer-driven programs are now calling the shots in our stock markets. It has truly become a casino.

Take Thursday’s 3% up day on the S&P 500 Index, for example. It is no surprise that all 24 major sectors in that index finished higher, which is usually the case on 3% up days while the opposite occurs on big down days. Most remarkable is that we have had six such days in just the last ten trading days. The only time period since 2002 that this has occurred was in November, 2008. For those who don’t recall that bloody month, the S&P kicked off November 3 (the first trading day of the month) at 966, dropped as low as 735 and finished back at 896 on November 28. Of course the very next trading day (December 1, 2008) the S&P 500 dropped 80 points.

That does not necessarily mean history is going to repeat itself. However, it does seem to indicate that volatility breeds more volatility. As more and more investors abandon the markets, and the summer vacation season gets underway, trading volumes will become even lighter allowing for even greater market manipulation. The best one can hope for is that the deep trading pockets of Wall Street firms use their proprietary capital to slice each other up.

In the meantime, as the markets gyrate up and down, the economic recovery continues to gather traction. At the same time, the worries over our growing budget deficit lead investors to start discounting the possibility of a large tax increase at the beginning of next year. Ben Bernanke, chairman of the Federal Reserve Bank, made clear this week during House testimony that we were not going to be able to grow our way out of this massive deficit. That leaves only three options: cut spending, increase taxes or both. Politicians during my lifetime have not been willing to cut spending very much if at all, although they have been happy to raise taxes whenever they get into a budget bind.

Now that we are facing the mother of all deficits, I expect an entire raft of new taxes and it won’t be confined to just the business community or wealthy individuals this time around. We will all be hit and from all sides as federal, state and local governments raise income tax rates across the board. But it won’t stop there.

Capital gains, dividends and interest will all be taxed at a higher rate. Property taxes will skyrocket as our school systems protest that they can’t cut another dime out of their budgets. Estate taxes will climb. In fact, anything that can be taxed will be taxed. This combined new burden on you and I is certainly going to put a big dent in our disposable income. Of course, it will be even harder for the 9.8% of Americans already out of work.

Higher taxes, as far as I know, have never increased the growth rate of the U.S. economy, nor has it been good for the stock market. European countries, given their own deficits, have already embarked on a round of deficit reduction measures which economists predict will cut their future growth rates considerably. Should we expect that somehow, in our case, things will be different?

It is conceivable that this present pullback in the markets is at least partially related to the anticipation of future tax increases? After all, the markets are known to discount expected events six months or more into the future. It is food for thought. I’m also betting that you will not hear one word about a possible tax increase from either party or any of their candidates in this year’s election campaigns.
In the meantime, I remain cautious on the markets. We will certainly have more big up and down days. I can envision the S& P 500 retaking 1,100 or more as well as falling below 1,000 all in a matter of the next few weeks. Trade if you can, or stay on the sidelines if you can’t.

Posted in A Few Dollars More, At the Market