December 5, 2012
We are all cliff dwellers now — wondering about our fate as the Dec. 31 deadline looms for the economy's potential plunge amid political bickering about tax increases and the nation's debt.
In fact, the time to be rescued from a potential fall from the so-called fiscal cliff will be even shorter if Congress goes home for its holiday recess as scheduled at the end of next week. But much to the surprise of some analysts, the stock market has shown resilience, despite the prediction that the economy will go into a recession next year if about $600 billion in tax increases and government spending cuts take hold for an extended period after Jan. 1.
The resilience suggests that despite the nation's collective disgust with warring politicians, investors are confident that a timely compromise will be reached between the president and Congress that will keep the country out of recession — even if there's no consensus on tax increases and spending cuts by the deadline.
Perhaps people remember that even though Congress set off an almost-800-point plunge in the Dow Jones industrial average on the day it voted "no" on the $700 billion TARP bailout plan in 2008, spooked leaders of Congress approved the bailout two days later. Perhaps investors realize that while congressional bickering in August 2011 took the Dow down 635 points in a day, emergency action was taken. The can got kicked down the road, leaving Congress with the New Year's Eve deadline on spending cuts.
Despite the uncertainty, the Dow has climbed more than 20 percent since the August 2011 fiasco. It has climbed 6 percent this year, and the Standard & Poor's 500 is up almost 12 percent for 2012 as analysts debate the potential for economic damage if politicians dig in their heals and let taxes go up $500 billion.
Already, some observes see repercussions.
The November Institute for Supply Management manufacturing index, which measures the strength of the nation's manufacturing sector, surprised analysts this week by contracting more than expected. While some analysts said the numbers suffered because of superstorm Sandy, the National Association of Manufacturers issued a statement blaming the fiscal cliff. Amid concerns that businesses and consumers will cut back their spending if they face higher taxes and a recession next year, the association said manufacturers are already reducing their workforce.
"The economy is downshifting again," said Steven Ricchiuto, chief economist for U.S. Mizuho Securities. He said the ISM report showed new orders declining and employment in manufacturing falling.
Economist Paul Dales of Capital Economics noted that the weakness evident in the manufacturing index "is consistent with annualized GDP growth of just 1 percent."
That's feeble growth for an economy that's four years into a recovery from the last recession.
Yet Dales points to a scenario that hasn't been lost on investors who have continued to stay invested in stocks: "If the cliff is the culprit (for manufacturing's decline), a deal would trigger a bounce-back in the coming months," he said.
Beyond the belief that the stock market will probably rally strongly if the nation can put the cliff behind it, December also is the month when it's tough to bet against the stock market. It's the month known for Santa Claus rallies — the month when stocks tend to climb even if investors have been jittery up to that point. It's the time when mutual fund and hedge fund managers, who have been cautious investors earlier in the year and consequently are lagging behind the stock market, tend to try to catch up so their clients don't desert them.
That's a point JPMorgan strategist Thomas Lee has been emphasizing as he's urged investors to select cyclical stocks, which generally rise based on improving economies. Cyclicals have outperformed the S&P 500 since mid-October, he noted in a recent report to clients. "This is extremely curious to us. If there was risk of a fiscal cliff, we should expect severe economic consequences and hence, cyclicals should tumble. But instead we are seeing meaningful outperformance."
The strength of the stock market is also seen by Ned Davis of Ned Davis Research as an indicator that the economy is not going to go into a recession.
"One of my favorite leading economic indicators is the stock market," he wrote clients. "Despite all the eurozone angst, election uncertainty, disappointing earnings, Hurricanes Isaac and Sandy, and the fiscal cliff over the past year, the stock market has rallied nicely in line with good economic growth."