Uncertainty Around Fiscal Cliff Makes the Going Tough for Stock Markets

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Fiscal Cliff Uncertainty Pushes Stocks Lower

WASHINGTON, DC – DECEMBER 28: President Obama said he was ‘modestly optimistic’ while making a . [+] statement on fiscal cliff negotiations following a meeting with Congressional leaders at the White House December 28. (Image credit: Getty Images via @daylife)

There was little Christmas cheer in the equity markets. US stocks dropped during each of the four trading days this week. For a second straight week, the main culprit was sagging confidence for a last minute fiscal cliff solution. A Friday afternoon meeting between President Obama and congressional leaders failed to produce tangible results, though some lawmakers continued to voice optimism a deal can still be reached before year-end. Fiscal cliff uncertainty overshadowed a pair of encouraging housing reports.

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Major Events:

  • Wednesday – The Case-Shiller home price index showed single family home prices rose 4.3% in October from a year ago.
  • Thursday – The Conference Board’s index of consumer confidence unexpectedly fell to 66.5.
  • Friday – Pending US home sales for November rose 1.7%, ahead of most expectations.
  • Friday – President Obama met with congressional leaders to search for a fiscal cliff solution. It was reported that Obama would seek an up or down vote for his proposal on extending tax cuts for families with incomes below $250,000.
  • Friday – Hewlett Packard announced the Justice Department opened an inquiry on its ill-fated Autonomy acquisition.
  • Friday – Russian President Putin signed a law banning adoption of Russian children by US families, thawing relations between the two countries.

Our Take:

With the world focused on the fiscal cliff and European debt crisis, 2020 proved to be a hard year to lose money in the capital markets. With one trading day left, the S&P 500 is up about 14%. Small cap and international stocks are up a similar amount. Bonds had another good year, with ten year treasuries up over 4% and corporates and international bonds doing better. Popular Gold ETFs returned about 5%.

But the major asset class individual investors held in record amounts in 2020 was the worst performing. Cash was trash in 2020, providing a negative real return. Cash has a role in most portfolios, but it should usually be a small one. There is no way know if 2020 will be as rewarding for stock investors as this year was, but there is near certainty that holding too much cash over the long term will put many financial goals at risk.

All of us at Personal Capital wish you a happy, peaceful and prosperous New Year.

Roundtable: It’s all about the fiscal cliff

Investors on Wall Street are nervous about the fiscal cliff negotiations in Washington DC. (Photo: Scott Eells, Bloomberg)

Story Highlights

  • The uncertainty over the resolution of the fiscal cliff makes forecasting difficult
  • Clarity is what companies and investors are looking for in a deal
  • Mergers and acquisitions may get a boost once a deal is reached

Stock market performance in 2020 might have a lot more to do with government policy decisions than P-E ratios. The reason: What laws Washington lawmakers enact to put the nation’s fiscal house back in order will affect the taxes workers, investors and businesses pay, the size of paychecks, the rules and regulations businesses must abide by and how fast the economy will grow next year and beyond.

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First up for lawmakers is to avert the fiscal cliff, or the growth-choking combination of tax increases and spending cuts that kick in Jan. 1 unless a divided Congress cements a deal to avoid it. Then comes the bigger challenge: coming up with a “grand bargain” that tackles the big issues, such as entitlement reform and tax reform, needed to put U.S. finances on a more sustainable path, provide more clarity to businesses and pave the way for a re-acceleration in economic growth. Whether the Federal Reserve keeps its stimulus spigot open will also affect how markets fare.Our Investment Roundtable participants offer their views:

USA TODAY: Will financial markets in 2020 be defined or held hostage by politicians and policy?

Liz Ann Sonders, Charles Schwab: It is a theme that has been unsettling for investors and may not be going away, although it may be lessening. Politics and politicians are much more dominant now in terms of everything from market sentiment to market performance, and from market volatility to economic growth. It is not just in the U.S., it is globally. It is something we never had to live with to quite the same degree that we do now, whether it is China’s currency and monetary policy, politics in Europe, not to mention what is happening here. That is just a tricky thing because that is sort of the ultimate wildcard.

Thomas Lee, JPMorgan Chase: I don’t agree that markets will be held hostage by policy. If we look at policy, it is really suppressing risk appetite. I think 2020 is a year that policy cloud diminishes.

USA TODAY: Is that bullish? Will that create clarity and give companies the confidence to take risks again with their cash?

Bob Doll, Nuveen Asset Management: The key is to unlock this massive private-sector savings rate, both at the corporate and individual level. I don’t know what does it. Certainly, the prospects of a deal could improve confidence. Companies might spend a little more money. Hire a couple more workers. Invest in a plant somewhere or in a new product line. We might get a little more growth out of it.

Ann Miletti, Wells Fargo Advantage Funds: By nature, management CFOs and CEOs tend to be optimistic people and want to grow their companies. They just need to know what the rules are. And that has been the problem: We don’t understand the rules. Once the rules are defined, everybody will figure out how to operate and what to do. And eventually they will go out and invest. We are not there yet.

USA TODAY: Is there a risk that any steps taken to remedy the fiscal cliff will result in European-style austerity here at home as a result of higher taxes and less government spending?

Dan Chung, Alger: That is the risk. I would rather go off the cliff than see President Obama’s $1.6 trillion tax increase proposal and little or no spending cuts.

Sonders: And spending increases.

Chung: In that environment, everyone will remain in the mode that they have been in, which is cautious.

USA TODAY: How important is the timing of any fiscal cliff fix?

Adam Parker, Morgan Stanley: The risk is: Do they just come up with a fiscal cliff plan and say, “We need six months to work out a grand bargain.” If so, it takes you out to the summer.

USA TODAY Investment Roundtable panelist Adam Parker, chief U.S. equity strategist, Morgan Stanley. (Video by Eileen Blass, USA TODAY)

Sonders: That could happen. We may just get a bill on the tax piece and everything else gets pushed out. In the process, if you get a sense that we are moving toward a grand bargain, that would be a huge positive.

USA TODAY: What’s more important to investors: a short-term fiscal cliff deal or a bigger agreement down the road that reforms the tax code?

Doll: A grand bargain would be so much more important. There are a lot of CEOs or CFOs who say: “Tell me the rules. Even if it is bad news, I would prefer bad news to I-don’t-know news.”

Sonders: What CEOs are saying is: “I can play against any team on any playing field that is even.”

USA TODAY: Any other positives from a fiscal cliff deal?

Miletti: One of the themes that I can see emerging from this is companies going out and doing more mergers and acquisitions, or M&A.

USA TODAY: If we do get an improvement in M&A, how does that help the market?

Miletti: Because, if you can find ways to grow as a company or strengthen your business, whether it is organic or through M&A, it is going to create more jobs, better profitability and higher growth. Because money is cheap, once policy and regulation issues become clearer, CEOs will re-engage, and go and look for growth opportunities.

Parker: M&A is good for stocks and stock pickers, but it is not necessarily an economic positive. Mergers are often followed by companies moving operations abroad and firing people domestically to cut costs.

Chung: I totally agree with the idea of more M&A. But on the flip side, I happen to have been a corporate lawyer and did M&A work. I can’t imagine doing a deal with all the (unknowns related to the) tax code provisions. How are you going to value the thing that you are buying or selling with all that uncertainty? So I think you are on hold again (as it relates to M&A).

USA TODAY: Is there a risk the market doesn’t like the deal? Will potential higher tax rates on dividends (which can go from 15% to more than 43% for the highest earners) and capital gains (which could jump from 15% to 23.8%) be a headwind for stocks?

Sonders: I hope that they come out with a dividend capital gains tax rate that is the same. That is why I think it is a two-step process. An initial sigh of relief that something has gotten done and then after that investors will say, “OK, let’s look at what it is that we have.”

Chung: We have to study it and see what the tax outlook looks like.

Doll: Look at the price of owning stocks compared to most other financial assets. There is a lot of negativism priced in due to all the policy uncertainty related to the cliff. To repeat, even if it is bad news it may still be OK for stocks.

Traders face fiscal cliff uncertainty over holidays

TORONTO — Holiday cheer will be swapped with a dose of fear after traders return from a holiday break this week as developments over the “fiscal cliff” negotiations keep the attention of investors, and will likely lead to erratic movements in stock markets.

The shortened trading week, and traditionally low volume levels around the Christmas holiday, will likely accentuate any market shifts related to developments in the stalled U.S. federal budget talks. Congress will reconvene on Thursday.

But before then, trading will likely remain calm in the shortened session leading up to Christmas Eve.

The Toronto Stock Exchange closes early on Monday at 1:30 p.m. ET, while New York markets end the session at 1 p.m. ET.

North American markets will remain closed for the Christmas Day holiday, and the TSX will also be closed on Wednesday for Boxing Day.

On Thursday, traders will return their attention to the ticking clock leading up to the year-end deadline.

Last Friday, stocks fell sharply after House Republicans called off a vote on tax rates and left federal budget talks in disarray 10 days before sweeping tax increases and government spending cuts are scheduled to take effect.

President Barack Obama said later Friday that he is “ready and willing” to get a big package done to deal with the fiscal cliff, adding there’s no reason not to protect middle-class Americans from tax increases.

Obama says he spoke Friday with House Speaker John Boehner and met with Senate Majority Leader Harry Reid. He says Congress should pass a plan to extend tax breaks for the middle class and extend unemployment benefits.

Obama says no one can get 100 per cent of what they want and there are “real consequences” to how they deal with the across-the-board tax increases and steep spending cuts scheduled to kick in Jan. 1. Economists fear the combination could deliver a blow to the U.S. economy.

A deal must be reached to avoid going over the so-called fiscal cliff,’ which would involve the automatic imposition of hundreds of billions of dollars in spending cuts and tax increases that could plunge the world’s largest economy back into recession and depress economies around the world.

“Legislators are under increasing pressure to act quickly to prevent the sort of acute market volatility seen before (the) agreement on TARP and a debt ceiling deal 16 months ago,” said CIBC World Markets senior economist Peter Buchanan.

Investors will also be squaring away their tax books for the year. Monday marks the last day for tax-loss selling for Canadian taxpayers selling equities through domestic accounts. The deadline for U.S. securities tax loss sales is Wednesday.

“Once you get past those tax-loss selling deadlines, the markets have to look ahead, because there’s nothing else you can lock in for 2020,” said Gareth Watson, vice-president of investment management and research at Richardson GMP Ltd.

“Once we get to Thursday and Friday people will start focusing way more on 2020. That’s probably when the Washington news and noise will have even greater influence and that’s probably where the volatility picks up again.”

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