The Market Likes the Fiscal-Cliff Tax Deal

Traders hug at the New York Stock Exchange on Dec. 31, 2012 Photograph by Scott Eells/Bloomberg

Though Maryland born and bred, Josh Scheinker affects a SoCal zen, complete with what seems like a surfer-dude tan and coif. But the senior vice president of Janney Montgomery Scott’s Baltimore-based Scheinker Investment Partners admits that fear and loathing toward the fiscal cliff had shattered his calm. “My wife and kids,” Scheinker says, “were all wondering why my New Year’s was so stressful, why I was watching C-SPAN, and whether I needed to be in a white padded room.”

Scheinker, along with rest of Wall Street and global markets, celebrated Wednesday after Washington churned out a 13th-hour deal to stave off $600 billion in tax increases and spending cuts. All manner of risk assets, including stocks and commodities, surged to start 2013, after the House’s 257-167 vote on the hastily cobbled-together deal. The Dow Jones Industrial Average, Standard & Poor’s 500, and Nasdaq rallied an average of 2.65 percent. Europe and emerging markets rejoiced. Catastrophe avoided. At least mostly, for now.

Uncle Sam will permanently tax dividends and long-term capital gains at a 10 percent, 15 percent, or 20 percent rate, depending on a person’s or household’s overall income. Without this new certainty, the levy on dividends would have automatically jacked up to taxpayers’ ordinary income-tax rate. The bad news: Taxpayers with modified adjusted gross incomes of more than $200,000 for individuals and $250,000 for married joint filers will have to pay an additional 3.8 percent Affordable Care Act tax on their net investment income.

It’s a tricky grab for lawmakers on both sides of the partisan divide: How much and where, specifically, do you tax investors, who have been privy to a multiyear bull market in equities and fixed-income—an unavoidably attractive target for badly needed government revenue? How do you tap that source without choking off the undeniable wealth effect of a rising market? Love them or hate them, the top 20 percent of American income earners own about 90 percent of shares, a relationship that correlates disproportionately with retail sales, the health of which courses through the broader economy.

“Today the stock market has increasingly become the disciplining force in spurring action in Washington,” wrote Merrill Lynch economist Ethan Harris on Monday. “‘Stock market vigilantes’ have replaced ‘bond market vigilantes.’”

That’s a curious observation in light of how big a year markets had in the face of what was widely bandied as looming budgetary catastrophe. How urgently will lawmakers finish the substantial unfinished business of raising the country’s $16.4 trillion debt limit or deal with sequestration’s huge budget cuts if the market goes into panic mode?

For his part, Blackstone’s Byron Wien said the Standard & Poor’s 500 Index will fall below 1,300 this year (from its current 1,456). He correctly called the S&P’s ascent last year above 1,400. Not once last year did the market have a single day when it was down for the year.

“The hard work,” says Janney Montgomery chief fixed-income strategist Guy LeBas, “is far from done. The cliff represented the confluence of opposing needs to reduce the long-term budget deficit and support short-term economic growth. Congress, in this instance, opted for the immediate benefits of the latter rather than the stability of the former. That decision delays what will inevitably be tougher decisions in the long run.”

“So, is this a relief rally, a dead-cat bounce, or just an ephemeral rise?” asks Scheinker, who says he plans to glue himself to C-SPAN again next month. “Do I feel comfortable here? No, not really. Does the market truly understand what deal was just signed off on? I am not too sure. I can tell you that my clients are very worried about the future of America.”

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