Here’s the news of the week – and how we see it here at Mcalvany Wealth Management:

Congress Calls a Fiscal Cliff Timeout

The long-awaited yet partial conclusion to U.S. fiscal issues came Monday morning when Congress agreed to allow the Bush tax cuts to lapse, raising taxes in most cases upon the wealthiest earners in the country. Decisions regarding the debt ceiling and spending cuts were delayed into the months ahead. For your convenience, we’ve provided the “cliff bill” details below. Essentially, the bill satisfies about half of the government’s budget shortfall – at the expense of taxpayers and the economy. So much so that the Congressional Budget Office has made the prediction that the bill will drain government revenues derived from the economy by $3.64 trillion over the next 10 years, while increasing spending by $333 billion over the same period.

Republicans declare that the battle lines will be drawn when it comes to spending cuts come March, yet we doubt their resolve. Obama has publicly committed to expanding the debt ceiling (to infinite heights) while omitting any and all discussions regarding spending cuts. It’s a position that’s wise politically, since cuts equate to job losses (even if at the government level) – and that’s something the Democrats could never justify to their base.

1-5-13Stocks jolted higher Monday in response to the “deal” in Washington, while bonds took it on the chin. That theme lasted the entire week, although the momentum behind the move faded into Friday. Gold moved up in sympathy with stocks initially, but then suffered what seemed to be a temporary setback when the Fed minutes revealed that QE could possibly end as soon as June 2013 – a preposterous claim in our book, not worthy of discussion here. On the positive side, gold regained over half its losses by midday Friday while holding the line to a slow but steady technical advancement. Meanwhile, we’re moving toward larger ($85 billion/month), not smaller, Fed purchases in the weeks ahead.

U.S. economic data took a backseat to the events unfolding in Washington, but the data can’t and won’t be ignored indefinitely. Lately, the data has been skewed and/or dismissed for reasons pertaining to Hurricane Sandy and/or the fiscal cliff. While the former may have improved the data for a while, the latter is merely a reflection of extant economic imbalances – imbalances that higher taxes will serve to amplify in the near term.

Underemployment (U6) in the U.S., although improved from crisis levels, is still notably higher (14.4% for Dec) than at any point in the last 18 years. And job creation remains critically lower than the 250,000 jobs needed per month for a legitimate “recovery” to be declared – non-farm payrolls were 155,000 for December.

With the economy still on shaky ground and Congress standing ready to take the path of least resistance (i.e., more debt and limited cuts), it’s hard for us to see the Fed taking a back seat this year when it comes to monetizing. Thirty-year Treasury rates have been leaping higher lately (up over 60 basis points from the lows), and are perhaps sensing a funding crisis ahead at the government level. If left untouched by the Fed, they will throw the economic “recovery” into a decisive tailspin. Whatever the case, in the coming weeks we’ll be following the Treasury market closely to mark what could be a subtle end to a nearly three-decade bull market in fixed income.

Fiscal Cliff Deal Highlights:

U.S. Budget Deficit 2012: $1.141 trillion (including -$82 billion estimate for December)

  • Senate passes bill Tuesday morning (89 – 8); House passes bill Tues night (257 – 167). Bill set to raise $620 billion in revenue via tax increases (estimated to satisfy a little over half the deficit).
    • According to the Congressional Budget Office, the last-minute fiscal cliff deal reached by Congressional leaders and President Barack Obama cutsonly $15 billion in spending, while increasing tax revenues by $620 billion – a 41:1 ratio of tax increases to spending cuts.
    • The deadline for debt ceiling increases is set for February 28th, and spending cuts (of only $110 billion for 2013) for March 27.

New Tax Laws

  • Tax rates will rise to 39.6% from 35% on individuals earning $400,000 (the Democrats are upset that this has not been set at $250,000) or households earnings $450,000.
  • Taxes were raised on long-term capital gains and dividends by 5% to 20% for $400,000+ earners.  Those earning under $400,000 remain at 15%.
  • The bill does not extend the payroll tax, but will levy a 2% jump in the employee portion of the Social Security tax to 6.2%. (Most Americans are affected.)
  • Estate tax increases from 5% to 40%; the $5 million exemption threshold remains intact.
  • Extends unemployment benefits for one year.
  • Includes “Pease” provision, which eliminates up to 80% of the deduction for couples making above $300,000 or individuals making above $250,000 – this includes limits on deductions for mortgage interest and charitable donations.
  • Also includes a personal exemption phase-out of individual incomes above $250,000.
  • Alternative Minimum Tax will be permanently fixed (keeps middle class from being hit).
  • Extends child tax credit, college tuition (American Opportunity) tax credit, and earned income tax credit (low income) for five years.
  • Extends individual and business tax breaks for two years, and the Medicare “doc fix” for one year, preventing a 27% payment cut for doctors.

Best regards,

David Burgess
VP Investment Management