Politics, profits and patience

by Jim Stack, editor InvesTech Market Analyst

History suggests that Congress will act on the expiring tax cuts, but we feel any chance of action before November 6 is slim. How should this impact your investment decisions?

With the December 31 deadline, a lame duck session should reach a compromise, but it will most likely be a short-term fix or extension. Any long-term solution will probably be left to a new Congress and whoever occupies the White House after January.

As such, planning a defensive tax strategy for 2012-13 is like trying to hit a target while wearing a blindfold. However, planning our investment strategy is a little more straightforward.  

The first order of business is to not overreact. No one knows what will happen legislatively, but we have time to wait and see as the deadline approaches.  

In our experience, it’s not a good idea to let the tax tail wag the dog, so be careful about letting taxes dictate your strategy… at least until the congressional outcome becomes clearer.  

With that said, there may be some actions to consider closer to year-end depending on the congressional debate…

• If you have large capital gains in a taxable account, you might consider taking some profit before year-end.
• If you’ll be subject to the new 3.8% health care tax, postpone taking losses until next year to reduce net investment income.
• Also, with the biggest tax hike hitting dividends, one might consider shifting taxable accounts to focus on capital gains potential rather than seeking high dividends or interest… but wait until year-end to see where the legislative dust settles.

Other than these steps, potential policy changes are not a compelling reason to change your current investment mix to avoid taxes.  

Municipal bonds are currently at 40-year lows and Treasuries are richly priced with 10-year bonds yielding 1.4%, the lowest level since the 1800s.

In our opinion, stocks remain a far better alternative today, and long-term capital gains will continue to offer one of the best tax-reduction strategies.  

Although there is always potential for bear market risk, unlike previous bull market tops, valuations are not currently overextended.

Still, the deteriorating evidence showing a slowing economy is a concern. We’ve already reduced our invested allocation to 77% in line with the rising risks, and further adjustments will depend on how the evidence unfolds.  

For now, patience is the best strategy If tax-related action is to be implemented, we advise waiting until after the election to make such decisions.

As to the election, the path to the White House will likely be determined by the stock market’s performance in the 60 days leading up to November 6.  

If the stock market moves higher, then Obama wins. If it tumbles, then Romney wins. That’s not a 100% certainty, but with an 89.3% accuracy over the past 112 years – it is where we’d place our bet. Either way, we expect the next three months to be volatile for investors.

Learn more about this financial newsletter at Jim Stack's InvesTech Market Analyst.