Equity investors should remember the strong tendancy for the first two years of a presidential term to be weak, the third year to be very strong, and the final or election year to be fairly strong. Politicians postpone the “bitter medicine” until after the election, depressing GDP and stock prices in Years One and Two of the presidential term. That paradigm is very relevant now. Even though we are limping along with 1% GDP growth, an ISM Manufacturing of around 50, Europe in recession, and underwhelming growth in BRIC countries, the U.S. economy in 2013 will face:
- Payroll tax rate hike of 200 bps, hitting the take-home pay of all wage earners.
- 0.9% hike in the Medicare payroll tax on high earners (over $250K for a household), to fund Obamacare
- 3.8% hike in the tax on capital gains and dividends of high earners, also to fund Obamacare.
- Rise in marginal income tax rate of high earners (over $450K for household) from 35% to 39.6%.
- Rise in the income tax on dividends and capital gains from 15% to 20% for high earners
- The sequestration spending cuts are slated to happen on March 1. House Republicans are adamant that they will occur, and the debt ceiling gives them leverage.
- Small business’ preparation for Obamacare, which hits with full force in 2014, will continue to impede hiring.
This is a big dose of austerity for a weak economy, and the Fed can’t help because it is out of ammunition. Admittedly the Fiscal Cliff deal eliminates uncertainty regarding tax rates. The stock market was right to rally big today; it dodged a big bullet because tax rates and dividends and capital gains remain at equal, and fairly reasonable, levels. But tax hikes, spending cuts, and continued fiscal rancor in Washington – which Obama foolishly exacerbated on New Years Eve by gratuitously taunting Congressional Republicans– will keep growth anemic.
Complacency has increased, with strategists in the Barron’s survey more bullish on the year ahead in December 2012 than they were a year earlier–even though the PE is higher and earnings momentum is lower. Analysts forecast $113 in 2013 S&P 500 EPS while strategists are at $108 (versus ~$103 in 2012). While $108 looks reasonable, the probability of surprisingly strong earnings (as we had in the first half of 2012) is low. At 1460, the S&P 500 is trading at 13.5 x 2013E EPS. By year-end 2013 the trailing PE could well be 14.5x – 15x (compared with an average of 16.2x, 2005-H1 2007), implying a 9% price rise this year to 1600 —not bad in a low-single-digit world. However, administering to a weak economy a toxic policy mix of anti-growth regulation, spending cuts, and tax hikes focused on the most productive workers means we may well get recession scares over the course of this year, leading to significant stock market volatility.
Copyright Thomas Doerfligner 2013. All rights reserved.
