Have the markets already priced in a fall off the fiscal cliff?

December 28, 2012

Fiscal Cliff

Well here we are on December 28 with only a couple of trading days left in 2012, and it appears extremely unlikely that US government officials will reach any sort of agreement before the end of the year. Sharp tax increases and spending cuts will automatically be implemented next week until an alternate deal can be forged. The markets have been in a steady decline since October, as investors correctly predicted that this would happen. Markets are about 5% lower than the highs seen back in September / October, having rebounded from the 8% decline weathered in November.

As a value investor, the fiscal cliff may be the best thing to happen all year. It may be an opportunity to pick up some great companies at a much reduced price. The question I’m struggling with right now is whether the failure of the government to reach a deal and avoid the cliff has already been priced in to the 5% decline we’re seeing today, or whether we’re going to head off the deep end next week. There are of course many opinions on this matter. Brendan O’Boyle believes that we may be in for some rough times ahead. Stephen Gandel in contrast, feels that the markets may have good reason to be shrugging off the cliff.

I have my own prediction regarding what will happen. I don’t believe that there will be a fiscal cliff deal made before the end of the year. The true effect this has on the economy doesn’t really matter. There are a lot of investors still sitting on the sidelines hoping for a deal and it is the perception of what will happen to the economy that really makes the difference. That perception is that the US economy is heading back into recession.

I believe that we are going to see another market decline with the DOW heading back down to the 12,000 range that we saw back in summer. This will be based largely on panic selling. I do expect some sort of a deal to be worked out by mid-January, but it won’t be the permanent agreement – just another stop-gap measure to prolong the discussions. In short, I believe there’s some good bargains to be found in the near future.

This is only my opinion and I could be way off the mark. I’ll write about this again in a month or so about what really happens.

The image, “Cliff Base” is copyright © 2012 Wreck Photography.

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