What Will Obama's Tax Deal Do for Investors?

What Will Obama's Compromise Tax Deal Do For Investors?
What Will Obama's Compromise Tax Deal Do For Investors?

The biggest question many investors are asking about President Obama's compromise tax cut deal is how it will benefit the economy. But if those investors are hoping for a consensus answer from the watchers at Wall Street's securities firms, they won't be getting one any time soon: So far, there is little agreement about what the stimulative effects of the deal will be, or which parts of the compromise should get the credit if GDP growth improves.

Bernie Williams, a money manager at USAA Funds, says the payroll tax cut announced by Obama, lowering the Social Security tax from 6.2% to 4.2% for a year, was a surprise development that could boost the economy as much as last year's $800 billion stimulus package.

"I think it will provide some support for stocks," Williams says. "I think GDP forecasts are going to go up and if you think growth is going to be a little bit higher, that will have an earnings impact and a multiple impact."

David Resler, chief U.S. economist for securities house Nomura International, says investors should be happy mainly because extension of the tax cuts for all income classes averted a likely reduction in GDP growth.

"They should be cheering that we dodged a bullet, they shouldn't be cheering because of the payroll tax holiday or the unemployment insurance extension," Resler says. In his view, the extension of the tax cuts across the board "averted a calamity."

Bullishness From Goldman Sachs, Pimco

Stephen Stanley, chief economist for Pierpont Securities in Stamford, Conn., estimates the boost to GDP from the Obama tax package will be only 0.2% in fiscal year 2011 and just 0.1% in 2012.

Resler thinks GDP will go up 0.3% more in in the next four quarters, but expects that the longer-term effects of the package will cause growth to be reduced by the same amount in 2012.

Goldman Sachs, on the other hand, is quite bullish on the deal, saying that the Obama plan will boost growth by between 0.5% and 1% next year, "a substantial upside relative to our current forecast."

Bond manager Pimco is even more bullish. It raised its GDP growth forecast for 2011 from between 2% and 2.5% to between 3% and 3.5%, a full percentage point of additional growth. But Mohammed El-Erian, Pimco's chief executive officer, told reporters that he thinks most of that growth will come from the Federal Reserve's big stimulus program of asset buying known as quantitative easing.

Swimming Against a Tide of Local Government Budget Cuts

The stock market has moved only marginally higher since Obama's announcement, gaining about 20 points on the Dow Jones Industrial average, a rise of about 0.2%.

Williams says the lack of a bigger response was because the stock market had already priced in the expectation that Obama would agree to extend all the Bush tax cuts, and also find a way to convince Republicans to extend unemployment benefits.

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"It is incrementally positive, it's not earth-shattering or anything," he says.

He added that while the tax cuts will have a stimulus effect, investors must also to take into account the fact that the states and local governments are still cutting back, laying off teachers, police and other employees, and putting off needed repairs. That will have a negative impact on the economy, he says.

Resler forecasts unemployment will come down from the current 9.8% to about 9.1% at the end of 2011 thanks to the tax package and Fed's stimulus. But he doesn't expect it to decline further for a while: At the end of 2012, he expects the unemployment rate to still be 9.1%.

From that viewpoint, expect that there will be very little wealth effect for investors to capitalize on next year. Stocks might rise for other reasons -- they always do in the third year of a presidential term -- but the tax cuts won't be the reason.