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Economic News & Analysis—November 9, 2012

Lessons from the week that was

By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

  • We didn’t get a shake-up in U.S. politics, but politicians now have a shiver up their spines. Since the previous elections, Republicans lost some power in Congress while the president has lost some popularity. President Obama’s victory margin in the popular vote was the smallest ever for a re-elected president. That could be good in terms of crafting a compromise on the fiscal cliff. Leaders from both parties have already struck a more conciliatory tone.
  • Tax rates are almost certainly going to increase on upper-income individuals. If anything, the health insurance taxes under the Affordable Care Act (3.8% on investment income, 0.9% on earned income) will be implemented. Capital gains tax rates and dividend tax rates may go to 20% but probably not until a deal is crafted on the fiscal cliff. Higher taxes, in general, are bad for market valuations—especially for small-cap stocks—but a deal on the fiscal cliff could more than offset that.
  • Municipal bond interest will likely stay tax-exempt, though the exemption will probably be phased out or capped at the 28% rate. This will likely affect only the shortest end of the municipal bond yield curve, since the rest of the curve is influenced by many other factors. Valuations are still attractive.
  • Regardless of the election, look for growth in 2013. You might want to look globally instead of just locally for that growth.
  • Greece’s parliament narrowly approved more budget cuts. This frees up the International Monetary Fund, the European Central Bank, and the European Commission (the troika) to release another tranche of financing for Greece, which should be good for European equities and bonds.
  • China’s 18th National Congress of the Communist Party convened and will elect a Central Committee of the Communist Party by November 14. The Congress meets every five years to set goals for the nation’s economy and elect a Central Committee, which will then elect the Politburo. From the Politburo, a Standing Committee of seven to nine people will be elected. These will be the people who lead China for the next 10 years (they will almost certainly be re-elected in five years, when the 19th Congress meets).

    During the opening statements, President Hu Jintao, who is stepping down, set the goal of doubling the per-person income of the rural population by the end of 2020. Since China’s population is stagnating and only 50% of the population lives in rural regions, this is a more modest goal than the one set 10 years ago—and subsequently achieved—to double the nation’s gross domestic product. The new goal still requires rapid growth but slower than it’s been over the past 10 years. This could likely benefit businesses that cater to the rural population, which spends a lot of its income on consumer staples. This could also benefit companies that will help in building the water and sewage systems, the electrical systems, and the roads in these areas.

    Importantly, there was no mention of further political reforms at the Congress. Leaders reiterated their commitment to communist rule, but that shouldn’t be too surprising. This was, after all, the Congress of the Communist Party. Whether other political reforms will also result depends on the people who are elected to the Standing Committee, and they may not implement reforms until 2015.
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