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On January 1, 2013, the U.S. Senate passed the American Taxpayer Relief Act of 2012; shortly thereafter, the House of Representatives voted to adopt the Senate bill. One day later, on January 2, 2013, President Barack Obama officially signed the bill into law. In doing so, he brought to an end months of debate surrounding the so-called “fiscal cliff,” or a combination of tax-rate increases and automatic spending cuts set to take place on the first of the year.

But what, exactly, does the new law do? Moreover, what doesn’t it do? Finally, what does all of this mean for investors moving forward? In the discussion below, Manning & Napier seeks to bring clarity to this complex issue by briefly answering three questions.

What does the new bill do?

The bill itself is well over 100 pages long. In an effort to bring a degree of clarity to an issue that is anything but, the following are several highlights from the new bill:

• Bush-era tax cuts have been permanently extended for individuals and joint filers making under $400,000 and $450,000, respectively; those individuals and joint tax filers making more than this will now be taxed at a marginal rate of 39.6%
• Capital gains and dividends will be taxed at 0% for those below the 25% income tax bracket; for those in the 25% bracket and above, the capital gains and dividend taxes will now be 15%; for those in the highest tax bracket, capitals gains and dividends will now be taxed at 20%
• Estate and gift tax has been raised to 40% above the current exemption level of approximately $5.25 million in 2013 (and this amount will be indexed to inflation in the future)
• The 2% payroll tax cut has ended
• Permanently indexes the Alternative Minimum Tax (AMT) exemption to inflation
• Extends the emergency unemployment compensation and extended benefits unemployment insurance program through January 1, 2014
• Postpones federal sequestration, or automatic spending cuts, by two months

In all, the bill goes a long way toward providing clarity to taxpayers. While tax payers are unlikely to welcome these policy changes with open arms (as the tax obligation for all income earners will increase to some extent during 2013), the good news is that the veil of tax uncertainty that accompanied the “fiscal cliff” has now been removed.

What doesn’t the bill do?

As important as it is to understand what the new bill has done, it is equally important to understand what the bill has failed to do. Suffice to say, this is no panacea—the bill falls well short of the “grand bargain” many investors had hoped to see, and leaves much to be desired in terms of a long-term solution to rising government debt. There was no progress made in regard to cutting government spending and reforming entitlement programs. While increasing tax revenue is one way in which the government can begin to rectify its unsustainable financial position, it is critical that spending reforms are also part of the solution. Additionally, there was no mention of the federal debt ceiling in the language of the bill. The U.S. technically reached its debt ceiling on December 31, 2012, but through “extraordinary” measures, the Treasury has managed to avoid default. While it does not appear as though the debt ceiling will be an issue in the immediate future, it is an issue that will nonetheless require serious attention in the coming months. Debate surrounding the vote on whether or not to ultimately raise the debt ceiling has become quite contentious during recent years.

What does all of this mean moving forward?

Equity markets may continue to experience volatility in the months ahead as investors are still unsure as to what to expect from the government in terms of spending cuts. The U.S. economy remains on a slow growth path and reductions to federal spending are likely to act as an additional headwind. Essentially, all businesses will be affected to some degree by new policies that address federal spending. Therefore, any time that passes without clear direction from lawmakers on this issue creates challenges for the decision-making processes for both business leaders and investors alike. Clarity on tax policy is an incremental positive to be sure, but until investors obtain some answers on the government spending front, financial markets may continue to ebb and flow frequently with the tone of daily headlines and the extent to which it appears that politicians are making progress.

In the current environment, we do not see extremes in valuations–that is to say that stocks are neither overvalued nor undervalued. This means that volatility in the financial markets may present buying opportunities in the future. As such, expect to see us selectively take advantage of volatility created by uncertainty in the coming months.

As an active investment manager with over four decades of investment experience across all types of market environments, we are well prepared to help investors achieve their long-term investment objectives despite persistent uncertainty in today’s challenging environment. We have learned through time that investors tend to favor assets that they perceive as being “safe” when markets are more volatile. Today, these traditionally “safe” assets have had their valuations pushed to potentially unsafe levels, and such investments may not deliver the absolute returns needed over the long-term to allow investors to achieve their long-term objectives. Even short-term, income-oriented investors need to be cognizant of the risks that lurk today in traditionally popular income-producing investments such as U.S. Treasuries. Our active management investment approach allows us to navigate through prevailing risks in the current environment by focusing on specific areas where we see value. Today, we are pursuing companies with strong fundamentals and reasonable valuations, as well as companies with stable fundamentals and attractive valuations. In doing so, we believe we are positioning client portfolios to generate positive absolute returns in the long-term, such that investors are able to achieve their long-term investment objectives.

Analysis: Manning & Napier.

Sources: CCH Tax Briefing, www.ecfc.org, Council on Foreign Relations.

Manning & Napier Advisors, LLC is governed under the Securities and Exchange Commission as an Investment Advisor under the Investment Advisers Act of 1940.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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