Markets adjust to idea U.S. may go over the cliff
BY DAVID ROEDER Sun-Times Media December 27, 2012 9:56AM
(left) Susana Cuevas-Coffman of Hobart and her daughter Seila, 11, load their car after shopping Wednesday afternoon at Target in Hobart. Cuevas-Coffman waited until the day after Christmas to make some purchases, knowing they would be on sale. | Jeffrey D. Nicholls~Sun-Times Media
Wall Street is starting to buy the notion that the fiscal cliff won’t be so bad after all.
Investors have been bombarded for months with warnings about the yearend cliff, the mix of tax increases and government spending cuts that would happen automatically Jan. 1 without a broader budget deal.
Many warnings were from the politicians themselves, trying to build pressure for either a Democratic- or Republican-led agreement. But with time for compromise growing short and little movement evident in Washington, the financial markets have begun to doubt the severity of a yearend deadline.
The lack of a resolution is causing businesses to put off decisions about expansion or hiring. The Congressional Budget Office estimates a cliff stalemate will cause the U.S. economy to shrink 0.5 percent in the first half of 2013 and fall into recession.
If there’s no agreement by New Year’s Day, appearances will become important, experts said. “It will depend upon the body language of the president and the leaders in Congress as to whether they can get something done early in the new year,” said Marshall Front, chairman of the investment firm Front Barnett Associates LLC.
“The atmosphere is more important than whether the talks spill” into next year, said Paul Ashworth, an economist at Capital Economics.
In that event, some experts believe stocks won’t hurtle into a sudden, steep decline, even though Wall Street has acted on faith that the problem will be solved somehow. Stocks had their third straight decline Wednesday, but the falloff was slight and mostly involved reports of a glum Christmas season for retailers. The first holiday retail report, from Mastercard Advisors SpendingPulse, said sales growth was far below expectations and cited worries about the impending fiscal cliff.
The Dow Jones industrial average fell 24.49, or 0.2 percent, to 13,114.59, while the Standard & Poor’s 500 index fell 6.83, or 0.5 percent, to 1,419.83. The Nasdaq composite index fell 22.44, or 0.7 percent, to 2,990.16.
All the major indexes have advanced during 2012, but have managed hardly any gains in December amid the worries about the cliff.
The word “cliff” itself is a misnomer, said Jack Ablin, chief investment officer for BMO Private Bank in Chicago. If the tax hikes and spending reductions occur, their effects will take time to build, he said. “It will be more of a headwind for the markets than an actual plunge,” he said.
Conversely, a deal or the makings of one could send stocks into a short “relief rally,” with gains of about 5 percent, Front said. But he said the euphoria won’t last, as Wall Street will quickly move on to other matters.
Front said his clients already have prepared themselves, regardless of the political outcome. He noted that investors have shunned stocks known for their dividend-paying ability, because the favored tax treatment for dividends could end.
Ablin commented that for his clients, “most know that taxes are going to rise either way.”
Here’s why many are optimistic that a brief fall over the cliff wouldn’t upset the economic recovery:
♦Though the fiscal cliff would boost taxes by $586 billion for all of 2013, the tax hit for most people would be modest at first. The expiration of Social Security and income tax cuts would be spread throughout 2013. For taxpayers with incomes of $40,000 to $65,000, paychecks would shrink an average of about $1,500 next year. That would be a significant bite over the full year, but the initial hit would be just $130 in January, according to the nonpartisan Tax Policy Center.
♦About a third of the tax increases wouldn’t touch most Americans. Some would hit businesses. Others, such as higher taxes on investment income and estates, and the expiration of middle-income tax credits, wouldn’t come due until Americans filed their 2013 taxes in 2014.
♦The Internal Revenue Service has delayed any increases in tax withholding that would otherwise kick in. Without a deal, the top income tax rate for single people with taxable income between about $36,000 and $88,000 would rise from 25 percent to 28 percent. But that won’t start to reduce Americans’ paychecks in early January, even if no deal is reached by then.
♦About $85 billion in spending cuts to defense and domestic programs would take weeks or longer to take effect. That means government agencies wouldn’t cut jobs right away.