Winter 2013

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For Cornerstone Clients: Clients will receive their annual holdings and performance reports over the next few weeks as we receive year-end reports from the underlying managers. However, we wanted to send out our newsletter in advance as an outlook for 2013

Market Overview

The S&P 500 declined -0.4% for the fourth quarter, but increased 16% in 2012. The good news is that economic data has taken a turn for the better, despite political headwinds and gridlock. There are a number of recent positive indicators for the economy including consumer spending, capital expenditures, and financial investment. Oil prices are down. Europe appears more stable. The housing sector in the U.S. is improving. Real GDP in the third quarter was revised up to 2.7%, and inflation remains low. Household net worth increased by $1.7 trillion in the last quarter, and is closing in on the previous peak in 2007.

However, other indicators are moving slower and sending mixed messages. We believe we will continue to be in a high-risk, low-growth environment. Individuals continue to move out of the job market as they lose hope of employment. A lower unemployment rate due to individuals leaving the job market is a sign of continued job weakness, and is not positive for future economic growth. If the job market picks up steam, we would expect an increase in the unemployment rate as more people enter the job market looking for a job. That would actually be a positive sign for the economy if the job market is improving. Corporate revenues and profit growth have been slowing for several months. As we enter the corporate earnings season, we will be watching very carefully how many companies continue to revise downward their earnings estimates, an event which became popular starting last summer.

After considering Europe’s debt crisis, China’s slowdown, Japan’s struggles, and the U.S. GDP starting under 2%, the market fared much better in 2012 than most would have predicted. Although the Congressional compromise solution was achieved after year-end, the very same participants are already waging war on each other over the next battle, the U.S. debt ceiling. President Obama has said that he will not debate Congress to pay the costs of legislation that it’s already passed into law. He also mentioned that he will be looking for additional tax revenues down the road. The GOP

Senate Leader, Mitch McConnell, has stated that the debate over taxes is done with, and the only matter to debate is spending. As you can tell, this will not be a friendly debate. We believe that this debate could even be uglier than the fiscal cliff debate. If a compromise can be reached, we believe 2013 could be a good year for many asset classes as the economy has weathered the gridlock so far. However, if gridlock in Washington entangles the economy for a few more months, the stock market could quickly correct off its current five-year highs.

The “Fiscal-cliff” Notes

Below are some of the key provisions of the “Fiscal-cliff” deal signed at the beginning of the New Year. The legislation allowed some of the Bush-era tax rates to expire while maintaining others; it modified capital-gains and dividend tax rates for some taxpayers; and, adopted a few other provisions.

  • Income-tax rates: The maximum rose from 35% to 39.6% for individual incomes over $400,000 and households over $450,000.

  • Investment taxes: Capital-gains and dividend taxes increased from 15% to 20% for the same bracket as above.
  • Payroll taxes: The payroll tax on the first $113,700 in wages increased from 4.2% to 6.2%. We believe this tax will have the largest negative impact on the economy as this will be deducted from payroll checks immediately.
  • Estate taxes: The estate-tax exemption is $5 million and will be indexed to inflation moving forward. Taxes above this amount will rise from 35%to 40%.
  • Alternative minimum tax (AMT): The tax will be permanently adjusted for inflation.
  • Itemized deductions: Filers earning more than $250,000 singly or $300,000 jointly will be limited in personal exemptions and itemized deductions.
  • Sequestration: The automatic spending cutswere postponed by only two months.
  • Family credits: The Child Tax Credit and Income Tax Credit are extended for five years.

Knowing that the fiscal cliff deal was not a permanent solution or even a great short-term solution, the more important question to ask is probably which side of  

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Disclosures: This commentary is submitted for the general information of Cornerstone Wealth Management, LLC clients and may not be distributed to other individuals. This commentary is not deemed to be investment advice and information contained herein may not be current. An investor should consider the investment objectives, risks, charges, and expenses of each investment carefully before investing. For more complete information, you may contact us at 858-676-1000. Past performance is no guarantee of future results. Individual performance may vary and investment performance numbers may not be audited.