Fiscal cliff spells trouble for 2013 stock markets

8 Nov

Would a Romney victory have been better for share prices? That notion, popular on Wall Street, always smacked of wishful thinking as the Republican candidate’s proposed friendly tax treatment for corporate dividends had to be set against his intention to declare China a “currency manipulator” on his first day in office. The prospect of a trade war, or at least import tariffs, seemed quite capable of terrifying investors from the off.

It’s a redundant debate now. We can finally focus on the real action: how will the US approach its so-called fiscal cliff? The group of US institutional investors, led by BlackRock, that warned on the eve of polling that the budget crisis had been “barely discussed” during campaigning were correct. Now, though, the discussions will be loud and constant. Prepare for a volatile finale to 2012 for markets. Wednesday’s 2% plunge in the Dow Jones industrial average may just a taster.

Logic suggests a budget compromise of some form. Even a divided Congress, surely, won’t allow $600bn (£375bn) to be sucked out of a still-weak economy next year via spending cuts and tax hikes.

But the measures are due to be implemented automatically on 1 January unless Congress agrees a different course. Is it realistic to expect long-term thinking to triumph over the next seven weeks? It seems quite possible that the US could travel over the cliff before the games of political brinkmanship are abandoned and a scramble towards safety is enacted. The journey to that point, though, could be wild for markets.

Then there’s the nature of any eventual deal. Many broad-brush formulas have been proposed but there’s no Goldilocks solution. The US could suffer another downgrade to its credit rating if the agencies deem the measures too soft to prevent government debt reaching 100% of GDP. Alternatively, markets could be spooked if the cuts are deep enough to risk a fall back into recession. But one of those unattractive alternatives will have to be confronted in 2013.

The great hope of those letter-writing investment managers was that the piles of cash sitting on US companies’ balance sheets – $1.7tn by some estimates – will be put to more productive use once the magic ingredient of “certainty” appears. It’s an attractive and powerful idea. Just don’t expect to see much certainty in 2013. Even with a budget deal, there will be a lengthy postmortem on whether the right compromise was struck.

The best rule of thumb on stock markets and US presidents has always been this: the first year of their term is often the worst of the four for share prices. It looks a reasonable bet this time.

http://www.businessownersdirect.com

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