Reasons to Remain Calm

November 12, 2012

After the election, some are elated and others forlorn, but it is important to remain calm and react appropriately.
-Barry R. James, president and portfolio manager, James Investment Research

What a week! The market rallied on Election Day and then tumbled thereafter. For the week, the Dow fell 2.1% while the unweighted average we calculate fell less than 0.5%. More than twice as many stocks fell as rose and new lows are creeping up on new highs.

After the election, some are elated and others forlorn, but it is important to remain calm and react appropriately. The market slipped about 3% following the election, but this isnít out of the ordinary. In fact, the market fell 10% the two days after the election in 2008. However, we saw the market rise over 70% from the day of President Obamaís inauguration to the day of his re-election. This has been one of the best first terms ever for stocks. Of course, we have seen extreme government stimulus, deficit spending and monetary pump priming.

Many are concerned about the fiscal cliff, the combination of rising taxes and mandatory spending cuts. The spending cuts only amount to about 3% of annual spending, but they are concentrated on the defense budget. On the other hand, taxes will rise dramatically due to the expiration of the Bush tax cuts and the addition of new taxes because of Obamacare. The top tax rate will rise 16%, the top capital gains rate will rise about 60% and the top rate on dividends will rise about 190%. It is no surprise that those who fear this big jump in rates would look to sell in 2012. However, they may be jumping the gun. We donít know the final resolution to this issue yet. We are confident a resolution will be found and fears of the cliff will fade.

The market had been favoring more expensive stocks this last year. Looking from October to October, we found some disturbing results. The cheapest 20% of stocks by P/E, Price to Book or Price to Cash all fell during this period, while the most expensive rose. Bargain stocks had been underperforming this year up until October. We are starting to see a reversal, which could continue for a substantial period. Our research shows value outperforms about 8 of 10 times the year after an election.

Our short and intermediate term indicators are neutral and arenít giving an indication of a significant move in stocks. Any large move would likely be reversed fairly quickly, therefore, we would maintain fairly neutral equity levels and try to take advantage of these swings.