Uncertainty Around Fiscal Cliff Makes the Going Tough for Stock Markets

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The fiscal cliff and the economy
Pointless, painful uncertainty

by G.I. | WASHINGTON

Everyone agrees uncertainty is bad for the economy. But doing something with this observation is seriously hampered by the fact that uncertainty is almost impossible to define and measure.

Many academics count things that proxy for uncertainty, such as mentions of the word in news articles. That’s one of the components in the uncertainty index developed by Scott R. Baker, Nicholas Bloom, and Steven J. Davis whose work we wrote about it here; it links heightened policy uncertainty to weaker growth. It’s also used by Jonathan Brogaard and Andrew Detzel here; they find increased policy uncertainty leads to lower stock prices and private investment.

Establishing causality is tricky. A weak economy or a traumatic event like a financial crisis or terrorist attacks will both raise uncertainty and provoke a policy response, but it’s the economic event, not the policy, that raises uncertainty and hurts growth.

I have my own back-of-the-envelope exercise. I count mentions of the word “uncertainty” in the Federal Reserve’s “beige book.” As my nearby chart shows, uncertainty has shot up in the last month. (Some months are blank because no beige book was released then.)

The beige book is a narrative based on conversations between analysts at the Fed and business contacts throughout the country. While this means it’s not well suited to quantitative analysis such as mine, it does allow you to isolate the source of the uncertainty.

Usually, it’s the economic or sales outlook. Often, it’s an event beyond America’s control: the European crisis, higher petrol prices, Japan’s tsunami, and so on. Some months, though, the source is clearly exogenous policy decisions. In April of 2020, the federal budget was cited in three of that month’s 15 references to uncertainty. Recall that that month the government was on the verge of shutting down over Republican pressure for cuts to discretionary spending. One reference was to the future of Fannie Mae and Freddie Mac.

Uncertainty rose again in July; four of 14 references were related to fiscal policy, almost certainly because of the fight over whether to raise the debt ceiling (explicitly cited twice). The downgrade to America’s credit rating that following the debt ceiling negotiations and the intensification of Europe’s crisis sent stock markets tumbling, which explains the spike in uncertainty in September.

Uncertainty appears more often in this month’s beige book than any month since September. Five of 30 references cite fiscal policy, apparently a reference to the fiscal cliff. A sampling:

The Chicago District noted uncertainty over the effects of U.S. fiscal policy actions was reducing their customers’ demand for credit… The Boston, Cleveland, Atlanta, Chicago, and Dallas Districts said employment levels were flat to up slightly, with most contacts citing U.S. fiscal policy uncertainty or weak demand for their conservative approach to hiring… [M]any contacts had become more cautious about future spending decisions, pointing to the heightened uncertainty surrounding the federal fiscal environment and the upcoming November elections.

Conservatives and businesses often blame uncertainty about new regulations such as health care for the economy’s weakness. That argument doesn’t get much support from the beige books. This doesn’t mean they’re wrong. Many individual regulations may in aggregate produce significant uncertainty that doesn’t show up in this exercise. However, such background anxiety can’t really explain the periodic spikes in uncertainty and associated economic slowdowns. (Monetary policy, another frequently-cited source of uncertainty, is never mentioned as such in beige books I examined; on the other hand, consider the source.)

So this admittedly crude exercise seems to demonstrate that in terms of economic impact, fiscal policy trumps all other exogenous sources of policy uncertainty. Why does this matter? Because it’s so pointless. It’s not surprising or even necessarily bad that tighter fiscal policy leads to weaker growth. That may be the price of sustainable public finances. But the disincentives to hire and invest brought on by the debt ceiling battle and now the fiscal cliff aren’t the result of fiscal policy per se, but by the reckless and confrontational way that America makes it. Little wonder Ben Bernanke, the Fed chairman, spent so much of the last two days begging Congress to act on the cliff. Such action is not a substitute for more quantitative easing; but the stimulative impact would so much greater, with far fewer side effects.

Will Fiscal Cliff Uncertainty Defeat Market’s Favorable Seasonality?

It’s no secret that the stock market makes most of its gains in the winter months, and if it’s going to have problems they usually take place in the summer months.

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The pattern is so consistent that academic studies prove that over the long-term betting on the pattern even with a strategy as simplistic as the venerable old ‘Sell in May and Go Away’ dictum, outperforms the benchmark S&P 500 by a wide margin, while taking only 50% of market risk.

However, it doesn’t happen every single year. So by far the majority of investors remain skeptics, and in spite of their performance history believe there must be a way to be right 100% of the time.

Last year (2020) the market followed the seasonal pattern in classic fashion. The rally in the winter months of 2020-1011 topped out May 1, followed by a double-digit summer correction. The summer correction ended in October, and a typical winter months rally began.

This year followed a similar pattern – until June. A strong winter rally topped out in late April into a summer correction. But the correction ended at the June low, with a rally that carried the market up to a level fractionally higher than the seasonal May exit. At that point, exiting May 1 had not paid off.

But then the market pulled back again to a level lower than the May 1 peak.

The question for seasonal investors now, fractionally ahead of the market if they followed the spring exit and recent re-entry signal of my Seasonal Timing Strategy, is whether the rally that began in November was the beginning of a typical favorable season rally into next spring.

It’s been a nervous attempt to rally so far as uncertainties over the fiscal cliff negotiations continue.

That uncertainty is not being helped by the way several months of positive economic reports that indicated the U.S. economic recovery is back on track, have been replaced by some reports for October and November that are less supportive of that conclusion.

As I wrote last week, durable goods orders were flat in October after an encouraging increase in September, new home sales fell 0.3% in October, and consumer spending declined in October for the first time in five months.

On Friday this week it was reported that the University of Michigan-Thomson Reuters Consumer Sentiment Index fell sharply in early December, from 82.7 in November to 74.5 so far this month, much worse than the consensus forecast of 82.0

The Labor Department also reported on Friday that 146,000 new jobs were created in November, much better than the consensus forecast of 95,000. But previous reports for September and October were revised down by 49,000 jobs total.

But don’t count seasonality for the winter months out yet.

The wait and see attitude of business and consumers regarding the fiscal cliff, which has been creating the recent weakness in economic reports, would likely take a decided turn for the better again if a reasonable compromise is reached to avoid the cliff, or at least kick it down the road again.

And nothing in the typically slow negotiation process so far has disabused me of expecting that outcome.

By the way if that happens, although it would a positive for a few months, down the road the remnants could provide the catalyst for the seasonal pattern to continue next summer.

So I continue to be watchfully optimistic that a typical ‘favorable season’ rally will continue to come out of the rubble of the current uncertainties.

But it is still not a time for over-confidence, or to adopt a buy and hold approach.

Until there is more clarity regarding the cliff, I favor conservative holdings like the SPDR DJIA etf, symbol DIA, and the Utilities Sector, via etf’s like the Select SPDR Utilities, symbol XLU, while holding an ample supply of cash ready to pounce on more aggressive opportunities.

Why the Fiscal Cliff Is Bullish for Stocks

Going over the fiscal cliff may cause stocks to outperform. Michael Gayed, chief investment strategist at Pension Partners, reports on Markets Hub. Photo: Bloomberg.

This transcript has been automatically generated and may not be 100% accurate.

. is the dominating headlines you talking about here been reading about it . he sees the stock market stock market rises and pledged every word that comes out of Washington politicians mouths . everyone assumes that the fiscal cliff a very bad for stocks rate . maybe not maybe the fiscal cliff is good is bullish for stocks that Bush has talked . the talk about the right now Michael guy who’s chief investment strategist . at Pension Partners . you’ll colony right for of MarketWatch’s Trading Deck Clayton . Polish bullish the fiscal cliff on one he explained . let’s think about where we are now in the bond market we have the yields under the Fed’s inflation target of two percent so that means that if you’re in . a bind hold investor in bonds . it isn’t guaranteed to lose money in terms of how much are you spend . going forward . that would yield this low . stock in terms of inflation data just different lake aren’t going to write how much it meant that are cheaper . now . on a comparative basis stocks yield more than . that if you have the fiscal cliff in some way shape or form come to pass through which is essentially . some tonnage of tax increases plus some spending cuts austere . within the implication of that spending cuts makes the government the shoeless . decks of a supply of Treasury issuance is . shrinks from the current pace it’s been a . we know that that is the feast of the to buy from now on to condemn calmer . do Kiwi three . if you shrink the supply of debt . demand is still there you’ll continue to go down which means the bond only get more and more unattractive . than fair to compare to stocks and any kind of a . quilt will take a correction that’s coming in stocks and . becomes an instant buying opportunity this one we had this mini correction of me that’s what we just had me correction which seems to have ended . last week with is the Like formation . effectively would happen is as bond yields go down the stock yields go all the dirt correction . fiscal cliff makes . volumes go down even further making stocks even more attractive . and this is . the TTT EP ten days of the nine national title you call that their paradox . this is that with the Fed’s trying to do is in its society said Mark Albers of publishing next Muppet weren’t specific all this the primary because he had the gloom by doing the right or even well-known well-known financial surprise right is a very inching the person but you know the the the the main point that this is the Fed’s let’s hope the Fed wants the wealth for the Fed wants stock to rise housing to realize there for people to feel he’ll return deal the driver . still . carry them to do that if ever one still free to take risk you have to be the correction techniques no wonder . the magnitude . and the resilience the SOX has to exist for people to want to take risk . if we keep seeing that pattern . money will we be forced to chase the P Chase more people fill the wealth effect that’s the Fed’s gamble to increase economic activity right so it’s a meal and we just saw in November right in the November stocks went far down . into P a critical level or riding on talking about technical levels . then bounced back sharply Nancy as the Dow the Dow this morning . go back over thirteen thousand the SNP is . will that over fourteen hundred now . these smaller correction that’s when things really key cuz that’s what gives investors the confidence that did not comment on the stock market is ten twenty thirty percent right . isn’t there a risk though . that the longer those things build up along the you don’t have . that sort of claims in correction . more on helping the market gets shortly we know the markets can be un healthy for long periods of timing it still be very treatable the only real concern and becomes . the giver credit events . central bank eerily like the prevents that from happening into listening repeat something of a depressing one onlooker watch . and if you have given stiff cuts that would in Delhi summits and their parents the only problem . is that when you’ve commies like Apple which have so much cash in the balance sheet . they can we don’t become slowing economic activity . companies are very reluctant to cut back on dividends and have cash . so wanna just keep the cash . going out to them they’ll causing the deal to stay with us . now it’s about the fiscal cliff itself I mean . most people in the market think that there’s going to be some kind of deal I think is going to some kind of deal with a permanent solution band aid whenever . but again this is the other wrestlers firing up the risks are what is nothing to stop . I mean we saw with that with the did the debt ceiling debate last summer when nothing gets done . everything reverts back to spending cuts go in and that that that we’ll camp on the economic growth comes to . the SEO industry statistics you can spend even if we dig over the fiscal cliff is about . roughly a hundred nine billion dollars the euro . of spending cuts hundred nine billion dollars a year in the context of the SNP five hundred . which has a market cap of fifteen trillion dollars in total . is actually in really not that much I certainly understand the perception that it can cause Recession . we view this low when the markets themselves the more stimulative . and bigger than anything happens on the government side . I question whether it actually to be as negative as people think it’s going to be . even if legal for . them . knowing about . each of the wealth of the wealth effect that the Fed . on ECB Min prime the pump this up for a long time heals on the ten year Treasury bond been below two percent for wanting . to use this exact situation when Matt had been in place for a while . haven’t really seen a surge into the stock market Miata sleepy one that in the vines and very low . on . does this will affect ever really taken . so I’ve been calling this next juncture in the fall was on the bill for making the seasonal calls . will cause people to chase openly is when the headlines read down its new Will composites which . I’ve been saying since late September following the corrective period . would probably happen this year you see new all-time eyes . peeled . people love to chase pass prices moved within me that once you have sought to clear . some of these you know . all prior highs before the financial crisis hit . people say OK now’s a good time to invest on getting nothing much economic getting nothing in bonds . and here I am entered riddles or at least the perception of rails making more money by investing . in stocks . write . to Mike and I think very much appreciate the time .

As ‘fiscal cliff’ looms, stock markets shudder at economic ‘uncertainty’

Tuesday’s election has stirred stock markets’ concerns about the economy, with the Dow Jones falling 2 percent Wednesday. The reason: Washington appears poised for gridlock – again.

November 7, 2020

  • By Mark Trumbull Staff writer

For an election that was largely about the economy, the result this week leaves a lot of economic doubts in its wake.

President Obama scored a clear win, but now has unanswered policy questions piled on the White House doorstep.

First among those is what to do about the “fiscal cliff” of scheduled tax increases and federal spending cuts. Unless the president and a politically divided Congress take action, the economy drives over that cliff on Jan. 1.

That may explain, in large measure, why US stock indexes fell sharply on the morning after the vote. The Dow Jones Industrial Average slumped more than 2 percent in early trading Wednesday.

“The re-election of President Obama removes one uncertainty” for investors, economists Paul Ashworth and Paul Dales of Capital Economics wrote in a Wednesday analysis. “But they are none the wiser about if, how and when Congress will deal with the colossal tightening in fiscal policy scheduled to occur early next year.”

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The tax hikes and spending cuts would dampen consumer spending (by households and by the government), threatening a new recession. Forecasters widely expect some bargain designed to change the cliff into more of a gradual slope.

But how such a deal will shape up, in the current partisan climate, remains unclear. Will Mr. Obama seek to hold firm on his view that an extension of Bush-era tax rates should exclude the rich? Will resistance to tax hikes within the Republican-controlled House stymie efforts to strike a “grand bargain” that mitigates the cliff in the near term while also reducing long-term deficits?

The analysts at Capital Economics in Toronto predict that Obama “will struggle to garner bipartisan support for a more comprehensive agreement [on] how to put the nation’s finances back on a sustainable path.”

Obama used his victory speech, delivered in the wee hours of Wednesday morning, to focus above the partisan fray – on things that unite Americans rather than divide them.

With the cliff just weeks away, however, bargaining on the issue is moving immediately into high gear.

Senate majority leader Harry Reid (D) said Wednesday that any solution should include higher taxes on “the richest of the rich,” but also that he’s “not for kicking the can down the road” into next year.

Delaying the issue until next year could be hazardous to an economy that’s already fragile, growing at an annualized pace of 2 percent or perhaps a bit less. Current forecasts, which assume some resolution of the “cliff” problem, call for similar tepid growth in 2020.

Wednesday’s stock market weakness was also fueled by reminders that the economic clouds aren’t limited to the US. Traders were also listening as European Central Bank President Mario Draghi spoke of economic weakness in the wider euro zone.

Back in the US, investors are also weighing what Obama’s win will mean for other economic issues, ranging from energy policy to restructuring the corporate tax code. Obama has called for tax reform, but has sketched a different vision from that of House Republicans.

And in the run-up to Tuesday’s vote, Obama voiced support for expanded development of domestic energy sources, but it’s not clear if energy policies will change substantially in a second term.

Where the election does provide some new certainty is on health care and banking regulation. Obama’s Affordable Care Act and Dodd-Frank financial rules now appear set to be implemented, whereas Romney had pledged to seek repeal of those measures.

On monetary policy, too, Obama’s victory may also be a win for “status quo.” Romney had pledged to replace Federal Reserve Chairman Ben Bernanke. Although it’s not clear whether Obama will reappoint the chairman in 2020, investors now aren’t expecting a significant shift in Fed policy.

Markets were spared one major form of uncertainty: doubts about the election outcome itself. Despite a close-fought race and some concerns about voting-machine irregularities, the overall outcome Tuesday was clear. No season of recounts or court review awaits.

The fiscal cliff, coupled with the need for Congress to revisit its “debt limit” on Treasury borrowing, would have made the coming weeks a period of high uncertainty no matter who won.

Longer term, some economists say that the most important task for Washington policymakers may be to improve the very institutions – from elections to public schools – that undergird economic growth.

That’s the view of Daron Acemoglu, a Massachusetts Institute of Technology professor who has studied how countries prosper or decay. In a book this year written with James Robinson of Harvard University, he argues that nations prosper by nurturing inclusive institutions, which in turn spread economic opportunity and lay the foundation for innovation.

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In a recent e-mail interview, Mr. Acemoglu cited several trends that raise worries about the future vibrancy of the US economy. Those include rising income inequality, lagging school performance, and a rising role of money and lobbyists in politics.

The good news, he says, is that “US institutions have shown great flexibility … in the face of similar challenges in the past.” But he argues that, with these issues posing a challenge for Republicans and Democrats alike, there is little room for complacency.

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