The financial media has been on fire with frightening stories
about the pending fiscal cliff due to begin on Jan. 1, 2013. The
fear in themarket is strongly reflected by a drop of more than 900
points in the Dow Jones Industrial Average since mid September.
But markets are driven by perception, not reality.
The fiscal cliff refers to the automatic spending cuts
andexpiration of the Bush-era tax cuts that are set to take effect
in the beginning of 2013, if Congress doesn't reverse these looming
fiscal policies. On the one hand, these policies are designed to
reduce the federal budgetdeficit and improve theeconomy in the long
term. On the other, they could potentially drive the country into
arecession next year, as spending cuts and tax increases would be
an added drag to the already-weak economic expansion.
But the real question is: Are these spending cuts and tax
increases really going to happen? I don't think so.
Congresswill likely have a short-term solution by the Dec. 31,
or at the very least, will be able to extend this deadline.
Political experts are on both sides of the fence, and everyone else
seems to have their own opinion of the situation.
But investors like you and me shouldn't fret. After all, there
will be opportunities toprofit , regardless of what happens. In
fact, I came up with a handful of stocks we should be watching
depending on which scenario pans out.
Scenario 1: Congress doesn't come up with a plan, and the
fiscal cliff happens as expected
Clearly, the fiscal cliff will have a negative effect on the stock
market. Stocks will likely have a difficult time gaining traction
at the start of 2013. The new tax laws will take the current
15%dividend tax rate up to about 39%. Remember, for the past 12
years,taxpayers in the 10% or 15%tax bracket haven't had to pay any
federalincome tax on long-term capital gains, while individuals in
higher tax brackets have paid a 15% tax on long-term capital gains.
This means the dividendtaxes will likely result in a migration away
from dividend-paying stocks to more growth-oriented stocks in an
effort to avoid the increased taxes.
In addition, strategies to avoid taxes will definitely come back
into vogue. In this sense, life insurance will likely become
popular as a tool to dodge taxes. Life insurance enables investors
to transfer wealth while legally avoiding income taxes. In
addition, money grows tax-deferred inside a life insurance policy.
This means life insurance companies such as
American International Group (
Hartford Financial (
will likely benefit from this scenario. Financial service companies
HR Block (
should also benefit as investors scramble for advice on how to
rebalance their portfolios.
Scenario 2: Congress comes up with a short-term solution
and the fiscal cliff doesn't happen or is delayed
I think this is a more likely scenario. Many stocks have been
pushed lower simply because of fears of the fiscal cliff. But once
Congress averts or delays the fiscal cliff, a relief rally in the
stocks pressured lower will likely occur.
If you look back to August 2011 when Congress waited for the
last minute to increase the debt ceiling, there was massive
volatility in the equity markets. Investors who bought into stocks
while they were at their lows made huge profits. The stock market
jumped higher when Federal Reserve Chairman Ben Bernanke simply
stated a deal may be pending to solve the crisis. Just imagine
thebullish buying triggered when the solution is worked out. This
is particularly true in fundamentally solid stocks that have been
beat down for no other reason.
Under this scenario, two stocks in particular are poised to
1. Verizon (
This telecom company reported strongearnings during the third
quarter of the year to 64 cents a share, almost in line with the
same period last year. Fourth-quarter earnings are expected to grow
13.4% year over year to 59 cents a share. But because of fiscal
cliff fears, the stock plunged in November to $40 prior to bouncing
back to around $43 a share.
Solving the fiscal cliff dilemma may easily pushshares back
above the 50-day simplemoving average of $45 and beyond. The stock
2. GNC Holdings (
The health food chain recently posted better-than-expected earnings
of 61 cents a share during the third quarter, a slight 5%
improvement from the year-ago period. The stock is projected to
earn 46 cents a share in the fourth quarter, a nice 32% increase
year over year.
Yet fiscal cliff worries pressured shares 7.8% lower so far in
November. Once these concerns are gone, this stock could easily go
above $40 a share.
Risks to Consider:
Regardless of what has happened in the past, the stock market
often surprises everyone with its reaction to economic events. And
sometimes, what we least expect happens.
Action to Take -- >
No matter the possible outcomes, it's important to stay tuned for
any financial news that could compromise your portfolio.
But if you agree with me that the fiscal cliff is an overblown
hype and will be solved soon, then investing in beat-down but
fundamentally strong stocks makes solid sense. If you believe the
fiscal cliff may actually occur, then investing in stocks poised to
profit from tax increase and spending cuts is the smart choice.
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