How Low Could The Markets Go? The Answer May Shock You…
Well, in terms of market performance, President Obama’s second term isn’t exactly starting off on the right foot. Since he won reelection, it’s fair to say stocks have been in free fall.
In fact, the Dow Jones Industrial Average is down over 600 points, while the technology heavy Nasdaq is down 160 points. And let’s not forget the S&P 500, which is down 73 points. Those figures equate to a 5% drop for all the major indices since November 7th… the day after the Presidential election.
So much for the theory that President Obama’s policies are good for the market…
Now to be fair, the recent sell-off has just as much to do with the looming Fiscal Cliff issue as it does with President Obama’s reelection. But it does speak volumes that the Dow fell 313 points the day after his victory was confirmed.
Now, speaking of the Fiscal Cliff…
I wrote in early October (when the Dow was 1,000 points higher) that the Fiscal Cliff was going to be a big problem for stocks. I went on to say that a market roller coaster ride was more than likely right around the corner.
Well, now that our coaster car is officially plunging, what exactly has investors screaming the loudest?
For starters, hefty potential tax increases on capital gains and dividends has nervous investors selling now and asking questions later.
You see, with President Obama sitting in the White House, the capital gains tax will likely increase to 20% (or higher) from the current 15%. What’s more, taxes on dividends could jump from 15%, to either 18.8% or 43.3%.
Given the possibility of massive tax increases, it’s no surprise investors are locking in gains in 2012.
And it’s also no wonder dividend stocks are taking the brunt of the selling. For example, big dividend payers like Enerplus (ERF) and EV Energy Partners (EVEP) are nose-diving as investors sell before tax increases hit on January 1st, 2013.
So now the question is, just how low will this roller coaster ride take us?
Let’s take a look…
Unfortunately, from a technical perspective, the Dow has the potential to drop an additional 500 points in coming weeks. As you can see in the chart above, the widely watched index broke through important trendline support last week (blue circle). And now that it has, the next major area of support is the 12,100 area (blue line).
As scary as it sounds, it’s at that point you should consider adding oversold stocks to your portfolio. Stocks will have fallen 10% from their September highs and a big market bounce will be highly likely.
But even then you have to exercise caution…
Higher tax rates on dividends and capital gains are only part of the reason stocks are selling off.
Markets could endure an even steeper sell off if there’s a long drawn out battle in Congress over the unresolved Fiscal Cliff.
Remember, if this looming budgetary nightmare isn’t solved by year-end, an estimated $807 billion will come out of the US economy in 2013.
That would be enough to slice 4% off US gross domestic product (GDP) next year. And with the US economy already on shaky ground, a hit like that would take the economy into recession… or possibly worse.
If that comes to pass, I wouldn’t be surprised to see the Dow collapse an additional 10%. That would put the Dow around 10,800… 1,300 points lower than the blue line on the chart.
What should you do?
Whatever you do, don’t panic.
Emotional selling is the last thing long-term prudent investors should do. In fact, you should be doing the exact opposite of selling by getting your shopping list ready. Even if the US economy heads over the Fiscal Cliff, there will still be great opportunities in specific stocks and industries.
And keep in mind…
If (but it’s a big if) Congress comes to a Fiscal Cliff agreement by year-end, we’ll see a phenomenal rally. And that means stocks that have been trashed due to dividend hike fears (like the two mentioned earlier) will represent an exceptional buying opportunity.
Until Next Time,
Justin Bennett
Category: Stocks, Technical Analysis
