In the aftermath of the elections, our nation faces a number of unprecedented challenges both immediately and in the near future. Here’s my best guess at how they’ll play out over the next few weeks and months ahead:
1. Fiscal cliff – part 1: Automatic spending cuts. As part of the 2011 debt ceiling compromise, members of Congress agreed to across-the-board automatic spending cuts beginning January 1 if the ‘super committee’ could not agree on a detailed spending cut plan. This would mean cuts for an estimated 1,000 government programs including deep cuts in both defense and Medicare. This is not going to happen. Neither is Congress as a whole going to resolve program-by-program budget cuts the super committee failed to do before this year ends. Over the past four years members of Congress have proven they are adept at the game of ‘kick the can down the road’ and I predict that their first piece of ‘compromise’ legislation since President Obama was re-elected will be to vote to ‘postpone’ the automatic spending cuts until sometime next year.
2. Fiscal cliff – part 2: Higher taxes. The Bush tax cuts are set to expire December 31st resulting in significantly higher income tax rates for both middle-income and higher-income taxpayers. This is going to be a game of ‘Bluff’ between the House and Senate. I suspect the U.S. House of Representatives to make the first move by passing legislation extending the current Bush tax cuts through 2013. Their explanation will be to, “Give Congress more time to work out a compromise”. The Senate will respond with the Obama inspired legislation offering to extend the Bush tax cuts for all but the wealthiest Americans…those earning more than $200,000 ($250,000 for couples) per year. We’ll have to wait to see who blinks first. My bet is that the Bush tax cuts will expire due to no action by Congress before year-end with the Republican controlled House and the Democratic controlled Senate blaming each other while the American taxpayer is left holding the bag. As part of this, I don’t expect Congress to renew the payroll tax cuts for the 160 million wage-earners.
3. Death taxes. As part of the expiration of the Bush tax cuts, the amount of wealth exempt from death taxes will drop from $5,120,000 this year to $1,000,000 next year. In addition, the tax rate on assets above those amounts will rise from 35% this year to as much as 55% next year. This means that many middle-income taxpayers who own their home and have enough life insurance to protect their family will, for the first time, face death taxes. Congress will not resolve this before the end of the year but I do expect that sometime during 2013, Congress will raise the exempt amount from $1,000,000 to $3,500,000 or higher and make the new law both permanent and retroactive to January 1, 2013. This is because President Obama had offered this as part of a budget compromise before the elections. A simple alternative would be to make the current law permanent thereby setting the exemption amount at $5,000,000 with automatic cost-of-living adjustments.
4. Deficit. Everyone is concerned about the deficit. Unfortunately, both Republicans and Democrats lack the political will to enact meaningful legislation that will significantly address this growing problem. We’ll hear lots of conversation from both sides of the aisle about what must be done but in the end I expect to see the deficit grow by more than $1 trillion in 2013.
5. Social Security and Medicare. It’s no secret that both of these programs are on a path of self-destruction in their current form. Something must give…but don’t expect a ‘fix’ over the next four years. First, the Republicans are scared to death that they’ll lose control of the House in 2014 and that Obama will be free to rule over all of Congress in his last two years. The Democrats are still stinging from their losses in 2010 and will avoid tackling the toughest issues we face. Again, expect a lot of conversation but little action.
What does all of this mean for investors? In a word…well two words, continued uncertainty. The markets hate uncertainty as do business owners so the markets will remain volatile and business owners will remain cautious. However, I don’t believe the economy will slip into another recession. The economy should continue its slow recovery including a slow recovery in the job market. Corporate America continues to strengthen their balance sheets by storing cash, reducing debt and closely monitoring their expenses. The stock market should see volatile but rising prices over the next four years. There will be upward pressure on interest rates and that spells trouble for the once-shining bond market.