TSP Talk Blog

4/11/12

Stocks fell off the table yesterday as the nice little low volatility 2012 rally has quickly turned into a little bit of a panic here. The Dow lost 214-points on the day and the charts of the major indices ended the day mixed technically.


For the TSP, the C-fund dropped 1.70% yesterday, the S-fund lost 2.37%, the I-fund fell 2.34%, and the F-fund (bonds) was up 0.14%.

The S&P 500 broke below some key support levels, areas I did not think we would see taken out on the first pullback. But depending on how fine your purple crayon is, there are still some levels of support around.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

This quick drop from highs reminds me of the early 2007 sell-off after some problem in China. It was a shake up, and the indices chopped around for a few days before resuming the rally and eventually moving to new highs.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

Going from new highs to a bear market is quite rare so there is still hope for the bull market, and this data from sentimenTrader.com shows that the downside may be limited from here. Per sentimenTrader.com:

1. The market made a 52-week high during the past month.
2. It has dropped for 5 straight days.
3. The last day suffered the worst drop.


Chart provided courtesy of www.sentimentrader.com

"As we can see from the table, the majority of the occurrences didn't result in tragedy. Only 3 out of the 25 didn't recover to a new high relatively quickly and slid into major bear market declines during the next year.

"The median amount of time it took for the S&P to rebound back to a new high was 33 trading days, though there was a wide variation - from as few as 3 to as many as 120, or nearly six months."

The indices were mixed in the technical damage that was done. The Dow and S&P 500 broke below their 50-day EMA, but the Nasdaq is trying to find support there.


Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

The Transportation Index, which is very sensitive to economic conditions, is nearly down to the 200-day EMA, so perhaps this leading index was trying to tell us something when it was not making new highs in March like the other indices.

Chart provided courtesy of www.decisionpoint.com, analysis by TSP Talk

The weak jobs report and the continued economic slowdown in Europe is what is having an effect, and the current talk of raising the capital gains tax is likely having an impact as well.

A quick primer on the capital gains tax: The long-term capital gains tax rate is currently 15% for anyone already in the 25% income tax bracket. That is for gains on investments held for 1 to 5 years. Gains from an investment held less than a year already have a tax rate equal to the ordinary income tax rate. You can see the long-term capital gains tax rate never gets higher than 15% before 2012, and 20% in 2013, no matter which ordinary tax bracket someone is in.



One side of the political isle says that those making money via capital gains should not pay a tax rate lower than someone paying ordinary income tax. It's about being fair since the capital gains tax (15%) is lower than all but the 2 lowest tax brackets, and those who earn an income from capital gains are usually in a higher tax bracket.

The other side says that investment income has already been taxed once when the principle was originally earned (ex. someone invests part of their after tax paycheck in the stock market), and also that increasing capital gains tax rates could deter people from taking risks with investments or starting businesses, if the potential net gains are lowered, and less investment would hurt the economy.

If someone was lucky enough to make $100,000 in a long term investment they'd have to pay $15,000 in taxes currently but it could be $25,000 to $35,000 if it were taxed at the ordinary income tax rate, and nearly $40,000 in 2013. Would that affect someone's decision to invest? Perhaps.

If that person lost $100,000 in the stock market in 2011, they can't write off the $100,000. They could only write off a $3000 maximum loss on their taxes, and rollover the rest to future years.

I don't get into politics very often here and I don't plan on doing it today either. I just wanted to point out why the market may be getting uneasy while the administration is promoting the "Buffett rule" which would increase long-term capital gains rates. No matter which side of the argument you may be on, this will impact investors psyche, at least in the short run.

One thing I don't like about the capital gains tax is the limits, and it has nothing to do with the rates. This has happened to me a few years ago:

If you made, for example, $10,000 in trading stocks in 2010, you pay the tax (it was short term ordinary tax rate) on the $10,000 gain. But if you lose $10,000 the next year, you can only write off a $3,000 loss.

Despite breaking even ($0 gain/loss) over the 2 years, you had to pay a capital gains tax on a $7,000 gain ($10,000 gain - $3,000 loss). The loss does rollover into the next year, but only $3,000 at a time so if someone in a high tax bracket lost a large sum of money (say $100,000 or more, which could easily have happened in 2008 to a big trader), they would really be affected by only being able to write off a $3,000 loss.

Let's say someone makes $100,000 a year and over the years accumulated a $100,000 nest egg to trade, but lost it all in what turned out to be risky investment like Lehman Brothers during the financial crisis. Since they can only write off a $3,000 loss, they would have to pay a capital gains tax on $97,000 despite having a zero net income that year.

Our TSP accounts are retirement accounts and our gains are not taxes as capital gains but at the higher ordinary income tax rate, so it would not be impacted by a capital gains tax increase. Only investments outside of retirement accounts are affected.

Thanks for reading! We'll see you back here tomorrow.

Tom Crowley


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