why a post-election selloff?

it’s all about taxes…

…in a very “small ball” sense.  Without action in Washington, G W Bush era income tax cuts will expire.  Two tax reductions affect investors directly:

–dividends from stocks, now taxed at 15%, will become taxable as ordinary income–meaning at about a 40% tax rate for the highest income holders, and

–similarly, the capital gains on the sale on stock held for more than a year will become taxable as ordinary income, rather than at the current 15% rate.

If–and I think that’s really IF–these tax breaks disappear, three consequences follow:

1.  stocks in general become somewhat less valuable to taxable investors,

2.  within the stock market, dividend-paying stocks become somewhat less attractive, since for high-income holders the after-tax yield is cut by 30%, and

3.  high-income investors having large gains in stocks they hold may be persuaded to sell before yearend.   Contrary to normal prudent practice, investors holding stocks with losses may consider not selling them until the new year, where those losses may  have greater value.

two counter-moves

IF the tax rule change, it seems to me that:

1.  Roth IRAs holding income stocks become much more attractive, and

2.  the mammoth tax losses that mutual funds and ETFs in existence prior to 2008 still have on their balance sheets become considerably more valuable.

adjustment implies selling

AAPL is probably the poster child for this.  Suppose you bought AAPL a few years ago at, say, $100 a share.  It’s now about $535. If you sold today your Federal capital gains tax would be $435 x .15  = $62.25 (remember, there may be state taxes as well).  If capital gains were taxed as ordinary income, your tax could be $435 x .40 = $174.  So, if you had a thought in your head about selling, you’d certainly prefer to do so in 2012.

talking heads are already pushing this idea

That really scares me, since these guys are in the vanguard of the army of dumb money investors.  We all thank goodness they’re there, since their existence–like that of doctors, lawyers and dentists (sorry, if you’re one of them)–lessens the chance that we’re the dumb money ourselves.  But generally speaking their “advice” is toxic.

what I’m doing

As usual, not much.  I’ve got to think hard about sector funds instead of some individual stocks, and about establishing Roth IRAs.  But my only concrete decision is to defer selling losers until January.  In this, my assumption is that we won’t know about any tax changes before yearend.

If we do hear about higher taxes on investments this month or next, I’d expect a ton of tax-related selling to ensue.  The best long-term growth stocks would likely be hit the hardest.   That would probably be a very good chance to buy.

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