From the August 01, 2012 issue of Futures Magazine • Subscribe!

Equities face steep fiscal cliff of worries in election year

Will equities fall off cliff? 

Also contributing uncertainty to the market will be the debate leading up to the scheduled fiscal cliff at the end of the year when the expiration of Bush-era tax cuts and automatic spending cuts could produce a toxic cocktail to the economy. “It will be the debt ceiling debate all over again, and it would be happening in the fourth quarter. At this point, there may not be the same level of certainty that the fiscal cliff is going to be resolved like we knew that the debt ceiling eventually was going to be raised,” Patton says, adding that this could result in a 10% haircut to equities markets.

Others take a more sanguine view of the fiscal cliff. “That won’t happen until the end of the year and what I’ve heard from a lot of different sources is the most likely thing is they are going to agree not to put in the fiscal cliff,” says Benoit, suggesting that politicians running for office in November will not want to have a pending threat to the economy hanging over them. “They’ll push everything out by three months or six months, and when they get close they’ll push out for another three or six months.”

Also questioning the likelihood that the fiscal cliff actually will materialize is Larson. “I kind of doubt that Congress is going to let taxes rise at such a steep rate all at once,” he says. “We can indeed expect higher taxes down the road, but I’m doubtful that it is going to happen all at once at the end of the year. In other words, if I had to bet on action or no action, I’m betting action on Congress’ part.”

Larson adds that the United States is not in the same situation as Europe, “but we are headed there if we don’t get our own fiscal house in order. Given the fairly large budget deficits, it means that we can expect either lower government spending or higher taxes and maybe both in the future. Both those things are going to act as a drag on the overall economy.”

But, he notes that for all the handwringing that has been seen so far this year, the S&P was up close to 9% for the year by the end of June. “We’re on pace for a nearly 20% rise if this were to continue. That’s a pretty strong performance. It sure doesn’t feel like we’re in a bull rally, but the numbers don’t lie.”

Past performance is not indicative of future results, though, and the market likely will get more volatile as the presidential election kicks into gear. We already have seen some pretty large swings in equity indexes in 2012 thanks to a strengthening recovery in the first quarter, and then a failure to follow through as well as the boom-bust cycles of the Eurozone crisis. Plus, we haven’t gotten into the election season in earnest yet. Things may get rough.

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