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A Busy Week in the Financial Markets and a Summary of the Fiscal Cliff Coming

The blog is a summary of my thoughts and comments each week on financial markets. If you want my full, free newsletter, you can sign-up at www.forzainvestment.com

Not quite as fast paced as The Avengers movie (which I give at least 4 stars out of 5:), but there was plenty of action in the financial markets this past week. To give a quick rundown we had (1) a socialist elected in France, (2) a vote in Greece that weakened bailout support throwing their government close to even more turmoil, (3) strong earnings from US companies (except Cisco) to the point where 75% of companies in the S&P 500 reporting have now beat estimates, and finally (4) JP Morgan surprising everybody by announcing a $2 Billion trading loss due to the "Big Whale" trader in London.

The JP Morgan fiasco probably stole the thunder from everything else but it appears that it is an isolated "stupid error" as CEO Jamie Dimon admitted. I could write a whole blog on the issue alone but you can go online and read hundreds of articles already. Needless to say, derivatives are very complex and even the "experts" can easily get burned.

Last week I talked about the "Go away in May" strategy and I did receive a number of comments. I actually had my article published in Seekingalpha.com which was nice to see. (http://seekingalpha.com/article/570431-sell-in-may-and-go-away-well-sort-of-here-s-the-scoop

So if one goes away in May or the end of May, where does one go (until October)?  Here are a few options of what you can do with your money. 

1.  Park it in cash equivalents - Although the return is minuscule, you'll be assured of maintaining your principal

2.  If you want to continue to have market exposure, look for higher dividend paying stocks in less economically sensitive sectors.  Although this could become a "crowded" trade, you will be able to get a quarter or so of dividends while staying in the market. These sectors include Healthcare, Consumer Staples and Utilities as the first choice. In general, high dividend stocks should have a place in your portfolio. Remember, you are also subject to equity risk.

3.  Write covered calls on your existing holdings - This is a way of generating income while you wait. If volatility increases, this will increase option premiums and allow you to get a little more income. There are risks involved with writing options so you should consult a professional before embarking.

4.  You can buy shorter duration bonds or low-fee Bond ETFs. There is a risk to principal but you do get a little higher yield. 

5.  A mixture of the above will allow good diversification so you don't have all your eggs in one basket.

Before doing anything you should weigh transaction costs against the risk/reward and speak to a professional. The simplest thing to do is nothing and ride it out for the long term. The next simplest thing to do is park it in cash. I like having some extra cash available in the summer that you can use to buy good stocks that may have corrected to the point where they are very attractive to purchase.

I also would like to reprint a story I read from Pragmatic Capital. It concerns the fiscal cliff we face this year. Please give it a read as it is something that will really start coming more into focus as the year progresses and it is scary. Unless the US Congress takes action this year, the nation will be facing a "stimulus" reduction via changes in tax rates and federal spending provisions, all taking effect in late 2012 and early 2013. Here is the list of these provisions: 

1. The Alternative Minimum Tax (AMT), currently at 28% for those filing jointly with incomes of $74K or greater, will drop down to $45K. That means that middle class families making over $45K will not be able to use deductions (medical, etc.) to pay less than 28% in taxes - a substantial tax increase on the middle class.

2. The so-called "doc fix" provision, which is currently keeping the government from implementing a 25% cut on physician payments by Medicare, will expire unless Congress acts.

3. The Payroll tax cut will expire at the end of 2012, increasing from 4.2% back to 6.2%.

4. The Super Committee's inability to reach a decision last year will force mandatory cuts (sequester) in the US government's discretionary spending. A great deal of that will hit the defense industry.

5. Unemployment benefits for workers who have exhausted the standard 26 weeks of benefits will be phased out.

6. Numerous temporary research and development tax benefits to corporations will expire.

7. The 2001 and 2003 tax cuts are set to expire. This includes tax rates on those making over $250K as well as qualified dividends and in particular the 15% rate on long term capital gains. People are wondering why we are having a string of large IPOs this year (including may private equity backed IPOs), even in a less than friendly IPO environment. Part of the reason is that the current cap gains tax rate may be the lowest that the owners will be paying in the foreseeable future.

8. At the end of the year the infamous debt limit will hit again, potentially forcing further cuts. 

According to Goldman Sachs, the total of amount of dollars the US government will be taking out of the economy is about $600 billion. Clearly some of these provisions may be modified or extended. But given the sharply divided Congress and the contentious election year, the political impasse is likely to continue. A large portion of these tax increases and austerity measures may take effect. These changes will potentially be a positive for the US budget deficit, but for an economy that is still fragile and somewhat dependent on government stimulus, it will certainly generate a material drag on the GDP growth.

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.

Westfield Parent May 15, 2012 at 01:53 PM
Impressive, informative and substantive article. I thoroughly enjoyed reading it. Great analysis on the upcoming fiscal problems. However, the market is never rational. I am convinced that the current bull market (that started from March 2009 after the VIX reached over 80, what a washout that was) won't peak until after the VIX dips to single digits.
Khalisi May 15, 2012 at 04:21 PM
Not a fan of Advisors giving advice without knowing their customer. Compliance anyone?
Bob Centrella, CFA May 15, 2012 at 11:44 PM
The information contained in this blog is not intended to constitute financial advice, and is not a recommendation or solicitation to buy, sell or hold any security. This blog is strictly informational and educational and is not to be construed as any kind of financial advice, investment advice or legal advice. As I already mentioned in the article, you should consult a professional before making any moves. - Bob Centrella, CFA

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