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Stocks worth 9% less today than yesterday: How changes in capital gains taxes will affect YOUR portfolio

What Healthcare Bill Could Mean To The Market

By: iStockAnalyst Monday, March 22, 2010 1:28 PM

With Health Care Reform passing, investors can throw charts, trends, earnings... out the window. Nobody on the left or right has any idea how this new entitlement is going to play out and what its short and long-term impact will be on stocks or the economy.

iStock has read many of the same stories as our readers. One side says the reform will cut the debt by more than a trillion dollars in 20 years. The other side says bankruptcy is on the way; in all likelihood, the needle will come to rest somewhere in the middle.

iStock can say with certainty, once the American public cedes more of its money to the government, you can rest assured that this will be just the first bite out of the money apple.

In the two previous Social Welfare programs, Social Security and Medicare/Medicaid, the costs to the public rose dramatically in the years after passage. There is no doubt the initial sticker price will not be anywhere near the final price tag for Health Care reform. Nothing ever works to form; there are always unforeseen costs and unintended consequences.

But what will be the consequences for stocks and the economy; those are the questions you want answered.

To get a feel of what investors can expect, iStock looked back at the stock market's performance following the passage of Social Security and Medicare/Medicaid.

* A year after SS was signed into law; the Dow was up more than 29%.
* Investors weren't as fortunate following Medicare/Medicaid as the Dow was down 5% twelve months later.

If we had to pick a side, iStock would put it at 70% that the markets close 2010 lower than they are today and that the economy starts to sputter by next spring and a recession follows fairly quickly. Similar actions transpired when the two previous Social welfare laws were signed.

We feel this way because the Health Care bill will increase the tax rates on capital gains and unearned income i.e. dividends, rental income, CDs...

Cap gains are slated to move to 24% from 15% and unearned income for folks making more than $200k ($250,000 for a couple) will get an additional 3.9% tacked on.
What does that mean?

Let's say you have a $10,000 gain in IBM. At a 15% tax rate, you owe $1,500 in cap gains taxes. At 24%, the tax bill is $2,400, a $900 increase. Put another way, you owe 60% more in taxes. Instantaneously your investment has lost 9% of its value ($900/$10000.)

Wall Street will take this into account in valuing stock prices. Based on the new law, the markets are worth 9% less today than they were yesterday.

In addition, we anticipate, with all kinds of taxes headed higher in 2011 as the Bush tax cuts sunset, investors across the board will start their year-end tax selling earlier than usual.

This only makes sense. As Newton said regarding his Laws of Motion, "every action has a reaction equal in magnitude and opposite in direction."

As for corporations and their profits, if Caterpillar's (CAT : 62.41, 2.46) letter to Speaker Pelosi is any indication, profits and unemployment could join the opposite direction list.

According to Gregory Folley, vice president and chief human resources officer of Caterpillar, the bill "would increase CAT's insurance costs by at least 20 percent, or more than $100 million, just in the first year of the health-care overhaul program."

(We searched diligently and Caterpillar was the only major publicly traded company we found making such claims. We couldn't find any that said it would save money and increase profits.)

If Mr. Folley and CAT's calculations are correct, that $100 million a year will have to come from somewhere. It will come out of profits and from cutting costs, which probably means fewer employees and lower earnings per share for Caterpillar.

In the event CAT's situation is not an isolated incident, many large companies could be facing the same challenges with their bottom lines. Earnings are the mother's milk of higher stock prices. Anything that lowers profits will eventually lead to lower stock prices.

Again, it's foolhardy to say what this wealth-transfer will do to stocks or the economy with any certainty. The taxes don't kick in until 2011, so stocks could easily have a last hurrah before money mangers factor in the new cost of capital landscape. By then, we can only hope the economy recovers enough to absorb the new taxes, leaving room for stocks to head higher.

Businesses, on the other hand, are already busy with 3rd and 4th quarter planning. They will probably react more quickly than stocks. That could be why, despite better economic news, the White House has warned unemployment will remain stubbornly high. Until companies fully understand what the final health care product is, it‘s reasonable to believe they will hold back and only add new personnel if it's 100% necessary; part-time employees should probably be nervous or cross their fingers that they get a full-time offer.

In the end, we believe this is the most likely scenario: The cost for Health Care will be more than advertised, it will add to our nation's debt, the additional costs and taxes will slow the economy, perhaps into another recession in 2011, and stock prices probably rise a bit before investors feel the impact of higher capital taxes.

As an investor and American citizens, we hope our scenario proves to be incorrect and the critics are wrong. Here's to the proponents being correct and that health care costs go down and as a result, money is freed up for business and people to invest in economic growth, and the deficit shrinks.

Admittedly, we have our doubts and believe that "the best laid schemes o' mice an' men" will yet again prove to be true regarding Health Care reform.

http://www.istockanalyst.com/article/viewarticlepaged/articleid/3966092/pageid/1