David Joy Weekly Commentary - July 2, 2012 (2024)

Europe buying time; big taxes could be coming!

Posted Tue, Jul 10, 2012 at 6:24 pm ET

The decision regarding bank funding was made in response to the market reaction following the earlier plan to bail out Spanish banks by first lending to the Spanish government, which would then channel the funds to its banks. The problem with that structure was the increase in the amount of sovereign debt that would result, making it increasingly difficult for Spain to fund itself in public debt markets, and increasing the odds that it too, would need a bailout. The yield on 10-year Spanish debt receded immediately following the summit announcement, falling 65 basis points the next day trading. After surging beyond the perilous 7.0 percent level just 10 days prior, the yield settled back to a more comfortable 6.20 percent to end the week. Italian and Irish debt yields fell sharply as well.

The MSCI World index of global equities rallied 3.0 percent on Friday following the summit, while stocks in Europe rose almost 5.0 percent. In the U.S. the S&P 500 added 2.5 percent. For the month, world equities rose 4.7 percent, a sharp turnaround from their 9.3 percent decline in May. However, for the full quarter global equities still fell 6.4 percent. European stocks rose 7.8 percent in June after shedding 13.4 percent in May, but fell 9.3 percent in the quarter. The S&P 500 added a modest 4.0 percent in June, but following a 6.3 percent decline in May, still ended the quarter with a 3.2 percent loss.

The question now facing investors is whether last week's developments in Europe represent a lasting, positive turn in the crisis, or whether this is simply another episode offering only temporary stability that will eventually fade, like so many episodes before it.

The summit undoubtedly provides fiscally troubled countries, and their banks, a lifeline. And it moves the Eurozone closer to the political acceptance of fiscal union by socializing banking risk. And, if the decline in bond yields hold, it creates a condition in which Spain, Italy and Ireland may be able to access public debt markets and avoid the prospect of further assistance. If so, then it will be viewed as a huge success. However, what it does not solve is the fiscal imbalances in these troubled countries. And, it does not change the fact that economic activity in Europe continues to contract. Yes, a stimulus package also accompanied the bank funding announcement, but that is of little consequence. The structural reforms necessary to create competitive economies remains incomplete. And the task is made even more difficult by the realization that much of the rest of the global economy is still slowing. Also, not to be overlooked is the fact that the funding mechanism itself represents a claim on the assets of it contributors - in other words –debt. And of course, the resources of even the strongest countries, like Germany, are finite. So, we have another situation where time has been bought to allow for economic reforms to occur. Whether it is enough time is unknown. That will depend upon the political will of the people and their determination to do what is necessary. But, as we know, austerity is no fun. We have been here before, and the patience of debt markets is thin.

Healthcare Reform Upheld:

The other big news last week was the U.S. Supreme Court's decision to uphold the constitutionality of the healthcare reform bill. But it did so, not under the authority of the Commerce Clause, but rather under the authority of the power of Congress to tax. And tax it does. Somewhat lost in the debate over the legality of the insurance mandate are the actual tax increases contained in the bill. In general terms, for joint filers with adjusted gross income in excess of $250,000 capital gains taxes and dividends will rise to 18.8 percent from 15 percent on January 1st. They could go even higher if Congress does not address the so-called fiscal cliff, also set to arrive on January 1, when expiring provisions in the code would push the long-term capital gains rate to a combined 23.8 percent and the top rate on dividends to 43.4 percent.* In addition, for wages or other earned income above $200,000 for single filers or $250,000 for joint filers, the Medicare tax will rise to 2.35 percent from 1.45 currently.

The implications for investors are significant. And while it is generally wise not to make long-term investment decisions on the basis of tax implications alone, there are circ*mstances in which taxes should be considered, especially in terms of deferring or accelerating the recognition of income. Much will depend on the outcome of the presidential election. The Republican Party position is to repeal the law and replace it with something else, in which case these tax increases may never take effect. But, at least for now, this is the law.

The Week Ahead:

The U.S. economic calendar this week contains several potential market moving reports, with June employment on Friday at the top of the list. Expectations are calling for the creation of 90,000 new non-farm jobs and a steady unemployment rate of 8.2percent. On Monday we learn about the performance of the manufacturing sector in June, followed by the service sector on Thursday.

With the July 4th holiday occurring in the middle of the week, expect trading volumes to be light after midday Tuesday, potentially exaggerating trading movements, especially if Friday's employment report offers a surprise, in one direction or another.

Important Disclosures:

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These rates do not include the additional taxes due to the itemized deduction and personal exemption phaseouts returning in 2013, unless congress acts.

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other

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The MSCI World Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31 1969. The MSCI World Index(MXWO) includes developed world markets, and does not include emerging markets. It is not possible to invest directly in the index.

S&P 500 Index: Is an unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It is not possible to invest directly in the index.

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