Stocks Face Hurdle As Payroll Tax Hits Wallets

As politicians bickered and companies refrained from investing much of their cash horde on new equipment or employees, U.S. consumers kept spending.

That trend is credited with helping keep the U.S. economy on an expansion track last year, albeit a slow one, and is an often-cited factor in the stock market’s steady climb.

But that was 2012.

“The big question to be answered is what will the increase in payroll taxes do to consumer spending in the first quarter,” said David Kelly, chief market strategist at J.P. Morgan Funds.

Americans are now finding their paychecks cut by a 2% rise in payroll taxes, which fund Social Security. The two-year payroll-tax holiday came to an end with the last-minute deal to avert the steep spending cuts and tax hikes known as the fiscal cliff.

Any evidence that consumer spending slowed because of tax changes could knock stocks off their recent heady course. The S&P 500   this week reached a 5-year high and is up nearly 4% this year. Read more on U.S. stocks.

Those gains add to last year’s, when investors overcame fourth-quarter fears that the economy would return to a recession if the fiscal cliff wasn’t avoided. The index gained 13% in 2012, boosted by evidence the economy was recovering and that central banks around the world would extend monetary easing moves.

‘Oblivious’ shoppers

The months of rancor in Washington that led to the partial budget deal did not translate to any extreme distress for U.S. households, at least in terms of keeping Americans out of the malls and car dealerships during the holidays.

The Commerce Department said this week retail sales climbed more than expected in December, with the 0.5% rise in purchases the largest gain in three months, suggesting momentum in consumer spending as the year came to an end. Read more on retail sales.

“Consumers through the year-end remained fairly oblivious; they spent money; they bought cars; they bought homes. You saw confidence fall off a bit, but you wouldn’t know it through retail sales,” said Elizabeth Ptacek, senior vice president and a senior credit real estate analyst at KeyBank.

But that scenario could change in rapid fashion now that average Americans have received their initial batch of smaller paychecks.

The Commerce Department’s report on January retail sales, scheduled for release in mid-February, will be among the early indicators of just how big a dent the payroll-tax increase will make in the first quarter.

Many Americans experienced “political-theater fatigue” through the fourth quarter, making it easy to ignore ramifications of the bipartisan battles being waged on Capitol Hill, said Eric Wiegand, portfolio manager at U.S. Bank Wealth Management.

But the reality of the legislative drama is likely setting in now that folks “literally have less, with payroll taxes increasing by 2%, and fuel prices picking up too, which also act as a tax on consumers,” Wiegand said.

A glimpse of what’s likely to come can be seen in “some of the discounters that have announced earnings earlier, and are moderating expectations,” said Wiegand, who expects the wage tax “will shave the better part of a percent off of economic activity in the front half of the year.”

The payroll-tax cut is significant, said Ptacek, who cites estimates that it would reduce disposable income by $120 billion this year, with the average American household having $18 to $20 less to spend each week, or $900 to $1,000 a year.

“The paycheck is smaller, the bank account is probably shrinking, and many households simply don’t have any cushion to absorb the blow — it’s upper-income Americans that have savings. A lot of Americans are living paycheck to paycheck, so to absorb the blow and maintain the prior pace of spending is unrealistic,” she said.

Marketwatch