Politics & Policy - Be Prepared to Go Over the Fiscal Cliff

Be prepared to go over the Fiscal Cliff

Once again we are in full crisis mode in Washington as our elected “crisis managers” set out to resolve the pending fiscal cliff. We have written in the past that, given the history of Washington over the past four years, we expect an eleventh hour deal that only extends the hard decisions further out in time. Recall the debt limit increase of last year. And the magnificently named super committee that failed. The last minute negotiations to avoid the shutdown of non-essential governmental agencies are always amusing.

To reiterate the pending economic challenge, on January 2, 2013 this country faces a slew of new taxes and spending cuts that economist are sure will send this country into another recession. The impact of which will drain over $600 billion from the U.S economy. The nation is facing a $127 billion tax increase on Americans when the payroll tax cuts expire; $295 billion tax increase from the expiration of the Bush tax cuts; $24 billion in new taxes from ObamaCare; $87 billion tax increase in other tax provisions. The nation also faced $87 billion in defense and discretionary spending cuts and $35 billion in cuts from the end of extended unemployment benefits.

The Left

Even now, both sides are jockeying to position themselves to obtain the greatest negotiating leverage. This past weekend during his weekly radio address President Obama warned Republicans that there are only two possible outcomes for the coming negotiations, allow tax breaks to expire for the top two percent of American earners, or taxes will go up for EVERYONE.

Democratic allies in the labor movement are campaigning aggressively to lock in the lefts objectives. According to The Hill, “The American Federation of State, County and Municipal Employees (AFSCME), the National Education Association (NEA) and the Service Employees International Union (SEIU) will launch a series of radio and television ads on Tuesday that urges lawmakers to let the Bush tax rates for the wealthy expire while preserving entitlement benefits.”

Jim Messina, the president’s campaign manager is using social networking and email to get the message out to supporters regarding the president’s position in the negotiations. By using its “re-election machine”, there are hopes that the Obama administration will garner the appropriate support they need to take a hard-line stance. 

The Right

The right is also gearing up for battle. Speaker of the House John Boehner wrote an op-ed piece in the Cincinnati Enquirer simply stating that ObamaCare must be put on the negotiating table for cuts in order to proceed making the case that the country cannot afford the added costs. We are almost certain this will be a non-starter for democrats and further exemplifies the gap the two parties must bridge to come to a final settlement. 

Speaker Boehner is gathering the appropriate allies in Congress to counter the Presidents claims of an election mandate by stating his retention of the Speaker of the House position offers his own election mandate.

The Wall Street Journal opinion section this weekend conducted an interview with Grover Norquist, head of the Americans for Tax Reform group. Mr. Norquist has been an extremely influential advocate against the raising of taxes and has every Republican leader sign a pact with the American people that they will vote against such action. When asked if he thinks Republicans will yield to tax increases if the appropriate spending cuts are initiated the Journal wrote, “Mr. Norquist insists that this won't happen because Republicans who think Mr. Obama or Senate Majority Leader Harry Reid are ever going to agree to cut domestic spending or reform entitlements are "chasing imaginary unicorns."”

He goes on to state, “"I feel very comfortable with where the Republican leaders are right now," he says. "We are infinitely stronger than we were two and four and 10 years ago as a Republican Party. We should be much more confident. We should emphasize growth and do a better job spreading the message to all voters. Explaining to people why tax increases are bad for the economy—that should be child's play."”

Based on the weekend banter back and forth, an investor needs to understand that, in light of the pleasantries and thin market rally last week, the issue of the fiscal cliff is far from over.  

What this means for the Stock Market

Obviously the market is sensitive to the issue of the fiscal cliff and despite the holiday shortened market rally that ensued on meager volume, we are of the opinion, based of the preliminary readings that businesses and investors will continue to scale back as it becomes ever more likely that we actually may be going over the cliff. 

Former Chairman of the Federal Reserve Alan Greenspan said this past week that “the markets will crater if we run into any evidence that we can’t solve this problem.” Credit Suisse produced a survey that 38% of businesses surveyed have stated that they have cancelled or postponed planned investment and spending decisions based on the pending fiscal issues. This is currently being picked up the durable goods figures that have been declining. The next release will be on Tuesday.

Any prolonged exposure to uncertainty will have negative effects on the stock market thus we are staying in cash and quite possibly, as per our behavioral model, increasing our short exposure. We take this stance after further insight that we actually think we will go over the fiscal cliff, albeit for a brief period. If that were to happen, we anticipate further market downside from these levels.

Be prepared to go over the Fiscal Cliff

In our opinion, it appears the disagreement between the left and right is too vast to solve in the next five weeks. In addition, we believe we are wrong in our original assessment of an eleventh hour deal that only extends the hard decisions further out in time.

After contemplating each sides strategy over Thanksgiving turkey, we have come to the conclusion that both sides must WANT to go over the cliff temporarily. It will change the entire dynamic of the debate.

Ponder this: On December 31, 2012 the debate revolves around INCREASING taxes on the top 2%, DECREASING defense spending, INCREASING payroll taxes and DECREASING unemployment benefits.

On January 2, 2013, after we go over the fiscal cliff, the debate will resolve around DECREASING taxes for the bottom 98%, INCREASING defense spending, DECREASING payroll taxes and INCREASING unemployment benefits.

How much easier will it be for politicians to vote to reverse the damage than to make tough decisions before the crisis. What a difference a day makes. With this outcome, Democrats get everything they want, thus President Obama’s hard-line stance and Republicans will save face by not having to vote for tax increases on America’s wealthy.

It’s basically a complicated way of simply kicking the can down the road. Of course this is a controversial view and  we have been wrong many times in the past, but given the current conditions and what our models are saying, we will stay the course and believe this stock market correction has NOT come to an end.

 - Joseph S. Kalinowski, CFA

Twitter: @jskalinowski

References

http://www.businessinsider.com/durable-goods-orders-fiscal-cliff-2012-11

http://thehill.com/homenews/house/269133-tax-fight-has-feeling-of-deja-vu

http://online.wsj.com/article/SB10001424127887324352004578137112355225342.html

http://thehill.com/blogs/on-the-money/domestic-taxes/269147-tax-policy-center-adds-fuel-to-rate-debate

http://www.forbes.com/sites/steveforbes/2012/11/20/president-obama-clinton-prosperity-requires-clinton-sized-government/

http://www.americanthinker.com/blog/2012/11/senator_chambliss_to_vote_for_tax_increases.html

http://www.americanthinker.com/2012/11/whither_the_republicans.html

http://thehill.com/blogs/on-the-money/domestic-taxes/269181-chambliss-i-care-more-about-my-country-than-for-norquist-tax-pledge

http://thehill.com/homenews/house/268815-boehner-tightens-grip-on-gop-rank-and-file

http://thehill.com/business-a-lobbying/268807-unions-work-to-pull-talks-on-fiscal-cliff-to-the-left

http://thehill.com/homenews/administration/268587-obama-only-two-paths-available-in-fiscal-cliff-talks

http://thehill.com/blogs/on-the-money/budget/269103-business-leaders-seek-debt-ceiling-hike-with-fiscal-cliff-deal

http://www.americanthinker.com/2012/11/the_balanced_approach_is_an_unbalanced_lie.html

http://www.newsmax.com/Markets/Greenspan-markets-Fiscal-Cliff/2012/11/16/id/464513

http://thehill.com/homenews/senate/268977-bennet-and-alexander-give-leaders-emergency-backup-plan-to-avoid-fiscal-cliff

http://finance.townhall.com/columnists/larrykudlow/2012/11/21/obama_wants_higher_revenues_and_rates/page/full/

http://thehill.com/blogs/healthwatch/health-reform-implementation/269059-boehner-obamacare-must-be-on-table-in-debt-talks

http://thehill.com/video/house/269151-mcmorris-rodgers-clock-is-ticking-on-looming-fiscal-cliff

http://thehill.com/blogs/blog-briefing-room/news/269081-obama-campaign-uses-e-mail-list-to-rally-supporters-on-fiscal-cliff

http://www.businessinsider.com/another-week-gone-and-no-fix-for-the-fiscal-cliff-2012-11

 

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