11/14/12 – Stocks Get Whacked on Fiscal Cliff Negotiations

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Nov 14, 2012 10:04:21 AM

and tagged Fiscal Cliff, Politics and the Economy, Yesterday's News

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Remember when I said we would see more volatility as the negotiations played out in the press? Today’s front-page article in the Wall Street Journal (WSJ), “Obama Sets Steep Tax Target,” discusses how the President is using his proposed budget, with $1.6 trillion in additional revenue, as a starting bid. This is twice the additional revenue that he and Boehner were talking about in their last set of negotiations and is a nonstarter from the Republicans’ point of view. Surprise—stocks are down again this morning.

Obama is also reported to be under pressure from the left on the budget. Yesterday’s WSJ had “Labor Pressures Obama on Budget” on page A6, which was confirmed in today’s New York Times (NYT) with “Obama Tells Labor Chiefs He Won’t Yield on Budget.” Earlier this week, we saw the Republicans playing to their base; now we see the same with the Democrats.

All of this is normal and expected. Things to watch include the trial balloons sent out yesterday, and the House leadership contest now underway, with a relative moderate running against a more conservative member for the number-four position. Boehner has supported the relative moderate; if she loses, it won’t be a good sign for Republican willingness to reach a compromise deal. Today’s NYT has a good article on this on page A15, “Congress Resumes With a GOP Leadership Fight,” and there was another in yesterday’s WSJ, “Post Offers Hint of GOP Path.”

Likewise, the selection of the new Treasury secretary will be a sign of how willing the Democrats are to cut a deal. Selecting a candidate who is disliked and distrusted by the Republicans—as at least one of the leading candidates is—would not be a good sign.

Another thing to keep an eye on is consumer spending. Preliminary signs indicate that consumers are starting to get spooked by the fiscal cliff. There’s been a real disconnect between business, which has been on hold, and consumers, who have continued to spend. The most recent retail sales figures, however, show a slowing in consumer spending. We don’t know yet whether this is due to Sandy, which is certainly possible, or something else—like the fiscal cliff. If it’s not Sandy, the effects on holiday sales could be substantial. Since consumer spending is the largest part of the economy, if consumers were to slow down due to uncertainty, the damage from the cliff could start to appear even before the end of the year.

Business leaders are also getting even more concerned, per the article on page A6 of the WSJ, “Business Leaders Spooked by Fiscal Cliff.” That damage has already been done (see my earlier posts on uncertainty and unemployment), but it might get even worse.

Overall, we are now in a very volatile period. Expect the usual horserace news coverage, as first one side is favored and then the other. Expect the usual drama over events that turn out to be relatively minor in the scheme of things.

The model I use, living in New England, is snowstorm coverage. With each storm, the narrative goes from snowstorm to blizzard to return of the glaciers and the Ice Age, where the living will envy the dead. Then the storm actually hits, we shovel out, and life goes on.

A blizzard is certainly possible, but we will know that only when it hits, not from the news coverage.

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