Red Jahncke notes that a higher cap gains rate (from 2012 to 2013) may have muted stocks sales last year and that the January 2014 sell-off may be a sign of things to come. Read more here:
After last year’s low volatility and impressive gains, stock market investors have been whipsawed in early 2014. Stocks dropped sharply in January, with the Dow Jones Industrial Average tumbling more than 5%, and falling again Monday.
Yet the roller-coaster ride may just be getting started. Aside from the trouble in emerging markets and slowdown in U.S. manufacturing activity, there is a tax effect at play in the current market downturn, and it is likely to increase market volatility for the rest of this year.
In late 2012, investors sold huge amounts of investments with long-term capital gains to take advantage of the expiring 15% ” Bush ” long-term capital-gains tax rate before the current 23.8% rate for higher-income investors took effect on Jan. 1, 2013. These sales left investors with few unrealized long-term gains going into 2013.
Instead, as the market surged, investors’ new gains were held mostly in short-term positions, which they were loath to sell given that short-term gains are taxed at ordinary income-tax rates (39.6% for high earners). With this inhibition there was less sales pressure last year, and for that reason the market may have risen more than it would have otherwise. Indeed, last year’s 30% market gain exceeded most analysts’ predictions.This year may be different, with more stocks purchased in 2013 reaching a one-year holding period. With the gains now taxable at lower, long-term rates, investors will be less inhibited about selling when they get nervous. That’s what happened last month. The result? A rush to sell and the Dow’s worst January since 2009. These sales may have been fueled by stock purchased 12 months ago with the proceeds of the huge volume of last-minute sales in December 2012.