There is no more time-honored axiom on Wall Street than to “buy the rumor and sell the news.” With the prevailing wisdom being that there would be a “wave” election, resulting presumably in either gridlock or different policies, and that the Fed would get busy with another round of quantitative easing (QE), investors started to buy a lot of rumor beginning on July 2nd. Additionally, for good measure, they doubled down once more on August 26th.
With four days remaining until the election, if the polls are correct, the rumored electoral tsunami is on course to hit landfall, which will move one-half of the equation from the rumor column to the news column. The next day, November 3rd, the Fed will conclude the next to last Open Market Committee meeting for 2010. If the Fed-watchers and pundits are correct, the Committee will put the other half of the rumor mill to bed by announcing their intentions for the aforementioned next round of QE.
What was initially cheered by equity investors as a free hall pass from the hall monitor to embrace risk like there was no tomorrow is now coming under fire from, wait for it, wait for it, the bond market.
No less a figure than the largest bond fund manager on the planet, PIMCO’s Bill Gross, has penned a fairly scathing piece in his monthly Investment Outlook, which you can read by clicking here. While Gross and PIMCO don’t speak for the entire bond market, my suspicion is that their sentiments are shared by far more than far less.
In terms of the election, if the polls and pundits are correct the Congress, on paper, will have undergone an extreme makeover. What real effect, if any, will this have on the economy and the markets? What real effect, if any, will this have on you and me as investors?
The honest answer is that nobody really knows. To be sure there are some who believe there will be ABC policy changes that will produce XYZ results. This may become a fact or prove to merely be opinion, which are two entirely different things.
No matter which party ultimately wins the horserace, there will be no panaceas coming from Washington, D.C. There might, however, be some curveballs; specifically one that pertains to tax policy. By example, will investors sell dividend-paying stocks if they believe the income tax rate applied to dividends will increase? If investor psychology remains true to form, expect a majority of investors to have a knee-jerk reaction to what most surely will be perceived as a giant negative event. Forget the fact that the majority of equities are held in tax-deferred accounts and that before 2003, stock dividends were always taxed at ordinary income tax rates and yet, dividend-paying stocks still out-performed non dividend-paying stocks.
Conversely, what if the current income tax rate for qualified dividends remains in place? Will there be an equally strong knee-jerk reaction that results in an increase in prices for dividend-paying stocks?
While taxes do have an impact on returns, so do trading costs and management fees. These impacts pale in significance, however, to the long-term impact on performance that the companies you choose to invest in does. If you opt for speculative companies instead of investing in quality companies that represent good values, who cares what the income tax rates on dividends are?
I have never been a believer in letting the tax tail wag the investment dog. The fact is that investors have a silent partner named Uncle Sam. His hand will be in your pocket, to varying degrees, depending on what the tax code allows at any given time. Unfortunately, this is never going to change.
This is not to say that some government policies don’t negatively affect the markets and the economy. Sometimes intelligent, well-intentioned public servants make mistakes; they are human after all. And yes, sometimes these mistakes have long-term ramifications; enter the Law of Unintended Consequences.
In the governments’ defense, however, they often are just trying to clean up after the Wall Street circus. When left unchecked, Wall Street will generally exceed to excess. The government’s only antidote therefore is regulation, which if too heavy-handed, can stifle ingenuity and risk-taking. So the search for the perfect balance continues; capitalism can be a messy business.
Between unemployment, a shaky recovery, the Fed apparently behind the proverbial eight-ball and yes, the election, there are a lot of distractions for investors to deal with. The fact is though, there are always distractions. Our job is to remain focused on our investment goals, objectives and what we can control; namely when and what we invest in.
So pay attention and play defense as there could be some rough times ahead. There is no shame in protecting hard-earned gains with a stop-loss. Yes, you may get stopped out but as one of my most significant mentors often said, “Stocks are like streetcars; another one will come around soon.”
