President Obama recently proposed two plans: one to stimulate the economy with a combination of tax cuts and new infrastructure spending and the other to reduce the deficit. At first glance, these two measures appear contradictory because they serve opposite purposes. However, there is some logic between the two proposals in that one is for 2012 and the other is a long-term plan.
Not surprisingly, the short-term plan is the one with the tax cuts and added spending. It also happens to be that 2012 is an election year and politicians normally do all they can to stimulate the economy when their own job prospects are at risk.
The question for investors will be whether a new round of stimulus spending will work. What has transpired is that temporary measures, such as a tax credit for new homeowners or car buyers, work while the program is in effect but the increased activity is not sustained. This year, lower payroll taxes are in effect but higher gasoline prices have offset some of that benefit. President Obama plans to expand the payroll tax cuts to include businesses but how much additional hiring would be created is questionable, as the tax cuts would only be temporary.
The other issue, which is the structural deficit that caused the downgrade of the national debt, involves the plan to reduce the long-term deficit. Some of the cuts, such as reducing spending in Iraq and Afghanistan by $1 trillion are not new, as that has already been planned. The tax increases that call for limiting itemized deductions for the wealthy should work better than increasing their tax rates. With an increasingly service-based global economy, increasing tax rates too high will just cause activity to move offshore.
On balance, the stimulus proposed for 2012 should have some positive impact on the economy provided there are no major outside shocks to the economy, as has occurred this year. Nonetheless, don’t expect a large surge in new hiring unless consumer demand increases in a major way. The short-term stimulus has a good chance of passing. However, the long-term deficit plan will likely be altered significantly.
For the investor, a somewhat better economy in 2012 than 2011 appears likely with the stimulus, which should be mildly positive for the stock market. Near-term Europe, Greece in particular, is causing significant volatility. While some may be tempted to exit the stock market, the problem with market timing is that even if you sell at an appropriate time, there is a good chance that you will miss the upside before you are comfortable enough to reenter the market. Therefore, only a very skilled trader should consider making any major moves.
