Last Week in a Nutshell
Last week started out ugly with major indexes falling as much as 2.5% from the prior Friday’s closing prices to Tuesday’s intraday low prices. Recovery ensued Wednesday and on Thursday things were looking solid until around 1:15 p.m. when the President announced his new capital gains tax proposal. The major indexes, as you can see in the picture below, fell off a cliff and closed down sharply for the day.
Why did this announcement send the stock market into a selling frenzy?
The capital gains tax is the amount of taxes you owe to the government for selling a capital asset for an investment gain. Historically, investors have been rewarded for holding assets for the long term, as assets held for under a year have been taxed at a higher rate than stocks held for longer than a year. With this tax hike, the long-term (LT) capital gains tax almost doubles from 23.8% to 39.6% for individuals making over $1 million a year. Given the Net Investment Income Tax, the true long-term capital gains would be 43.4%.
This tax rate hike is just at the federal level – for wealthy individuals living in certain states/cities, you could be facing a 50%+ tax on your LT capital gains. Most notably, for individuals residing in New York City and California, you would now be facing a 58.18% and 56.7% LT capital gains tax rate.
Why NYC and CA matter
New York City is the financial capital of the world and California is home to the most prominent technology companies and start-ups in the world. The incentive for wealthy individuals residing in these areas to fund innovative startups and conduct a range of investments that would provide economic growth would be reduced. Why would a resident of New York City or California fund an investment knowing that between state and federal level, the government would take almost 60% of their gain? These are the same governments that continually waste tax-payer money and in particular, New York and California rank in the bottom ten in terms of states taxpayer return on investment (ROI). By that I mean, these two state’s governments invest taxpayer money atrociously.
Why taxes are being raised
The President reported that the tax raise will fund education and child care but the U.S. has a laughable debt problem, a massive federal deficit (see chart below), and we have a baby boomers retirement crisis. There are many more U.S. issues that need to be addressed and something needs to change, but I’m not one to believe that taxing the heck out of the country’s capital providers is the answer.
This new tax structure might send lumber prices to even further heights….
Due to Covid-19, low interest rates and other reasons, the housing market has reached astronomical levels. As a result of insane home prices, people have started to build new homes which has led to the price of lumber almost tripling over the last year.
Given the potential for an even more outrageous tax structure for NYC residents, I believe that this could help push lumber prices to even higher prices as people continue to flee the city and venture into states with less cumbersome tax structures.
Back to the markets…
Despite the whip saw price action last week, volume remained very quiet. My initial views throughout 2021 have been that the major indexes will reach massive all-time highs (ATH) given the zero interest rate policy and the endless printing of money. However, the more time that passes by, the less and less confident I feel in that view.
Right now, the Nasdaq is flirting with an ATH and on its daily price chart it has formed what technical junkies call a ‘double-bottom’ or a ‘W’ base structure accompanied by a ‘handle.’ This type of base structure is one of the more ‘bullish’ (positive) chart patterns out there. A notable issue with this W base is that the second leg did not ‘under-cut’ the first leg and according to famed trader/investor William O’Neil, “a second leg that doesn’t undercut the first down leg is failure prone.” This presents an extremely important inflection point, where the Nasdaq could break out of this W base and move to all-time highs or the base could ‘break-down’, and we could be in for some dark days.
Almost 40% of the S&P 500’s market capitalization reports this week with some of the biggest names in the world set to announce earnings mid-week.
We will really get an idea of where the economy currently stands after names such as Visa (V), Apple (AAPL), Mastercard (MA) and Chevron (CVX) report.
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