The Independent Market Observer

11/8/12 - So Much for the Honeymoon

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Nov 8, 2012 10:26:39 AM

and tagged Fiscal Cliff, Market Updates

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Wow, that was quick. The markets celebrated Obama’s reelection with a quick drop as investors shifted their focus to the problems in Europe and the fiscal cliff here in the U.S. All three papers headlined with the fiscal cliff in one way or another this morning. The Wall Street Journal and New York Times (NYT) addressed it explicitly, with “Focus Moves to ‘Fiscal Cliff’” and “Back to Work: Obama Greeted by Looming Fiscal Crisis,” respectively, while the Financial Times (FT) caught up on the election with “Obama wins but new battle looms.”

Yesterday’s market dip was significant, the largest of the year in both points and percentage for the Dow. It also took the market below psychologically significant breakpoints, at 13,000 for the Dow and 1,400 for the S&P 500, and put it closer to its 200-day moving average—another potentially important breakpoint. Now that we’re past the election, the market is focusing on the next set of challenges, and it doesn’t much like what it sees.

The fiscal cliff, as I’ve laid out in other posts and publications, has the potential to send the economy into a recession, possibly a deep one. The economy’s dependence on whether the White House and the Congress can come to terms is deeply worrying. The last time we tried this—in last year’s debt ceiling debacle—they could not, and Congress cut a deal more or less on its own. This time, the stakes are just as high, and the players are the same. Hopefully, all sides have learned something.

There are more incentives to cut a deal this time, of course. In the last go-round, both sides were reluctant to give the other an advantage going into the presidential election; that no longer applies. Last time, there was some disbelief on the Republican side that failing to reach an agreement would be a problem; this time, it’s pretty clear that we will face a recession if they don’t agree. Last time, the participants were sitting down in many cases for the first time; this time, they’ve been down the road before. Finally, the Republicans were coming off a victorious election last time; this time, both sides have been chastened somewhat, potentially increasing their willingness to compromise.

That said, it is pretty clear that negotiations won’t be easy or quick, and the headlines reflect that. “Compromise or Gridlock?” leads the business section of the NYT, and page 4 of the FT has both “Few signs of fiscal cliff concessions” and “Dismay as old guard on debt ceiling survives.” Politically, there is no advantage to an early deal for either side and much for last-minute pressure. The negotiations will be largely played out in the press, as both sides grandstand and posture to pressure the opposition.

With all of that, expect to see more uncertainty and market volatility until a deal is cut—if a deal is cut. Right now, the focus is on what might happen, and we will probably see both up and down shocks as press reports of the negotiations progress.

The thing to keep in mind is that this is a discussion we have to have; no matter how rocky the road, the resolution will put us in a much better place to move forward.

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