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Whatever agreement Congress reaches on the so-called fiscal cliff, the best deal for stocks will be one that provides a stable plan to reduce the deficit, according to market strategists.

Granted, that's easier said than done, but drawn-out uncertainty over what the rules will be in the new year -- for both businesses and individual taxpayers  -- has been one of the biggest impediments to economic growth.

Depending on the source of your figures, the automatic tax hikes and spending cuts set to kick in on Jan. 1 are expected to yield $500 billion to $700 billion to trim the deficit. Recently, The Wall Street Journal estimated the automatic spending cuts will raise $136 billion and tax hikes will yield $532 billion for a total of $668 billion, or 4% of GDP.

Among the many scenarios tossed around is the so-called "grand bargain," where the deficit would be reduced by $4 trillion over 10 years through more taxes, less spending and entitlement reform in programs like Medicare and Social Security.

Some sort of agreement is key to stocks, however. Political squabbling and stock market volatility go hand in hand, as was seen during the fight over the debt ceiling in the summer of 2011, when the CBOE Market Volatility Index (VIX) , or so-called "fear index," lived above the 25 mark for more than a quarter.

Grand bargain

A reasonable best-case scenario for stocks would be a grand bargain that spreads out the pain over 10 to 20 years, and comes in at just under $4 trillion in tax hikes and spending cuts, said Dan Greenhaus, chief global strategist at BTIG.

But don't expect any deals before the new year; such a notion is "utterly fanciful," he said. What's more likely to happen is some sort of down payment in the near term with Republicans yielding on some $30 billion to $40 billion in tax increases spread out over the next 10 years in exchange for the same amount in immediate spending cuts, Greenhaus said.

"Republicans are unmovable on tax rates as Democrats are on the retirement age for Medicare," said Greenhaus. "Those are sacrosanct."

Congress will likely take some "path of least resistance" that extends some Bush-era tax cuts and cancels some scheduled spending cuts, said Jeff Kleintop, the chief market strategist at LPL Financial. But it will take a firm commitment from leaders and not another Band-Aid to instill confidence in the stock market.

"If there was ever a time to enact long-term fiscal discipline, now is the time," said Kleintop.

Keeping it volatile

The fiscal cliff is only part of the problem. The debt ceiling will have to be raised again either in February or March and the U.S. still faces the threat of additional credit downgrades in 2013, he added. Given that, a best-case scenario for stocks would be a firm agreement to reduce the deficit by about $2 trillion over the next 10 years via cuts to entitlement spending and defense and about $800 billion in tax increases, Kleintop said.

Even though $2 trillion falls short of the $4 trillion that's being tossed about and corporate earnings would likely suffer for a few quarters, such a compromise would signal real progress toward fiscal stability and likely trigger a rally of up to 25% in stocks for 2013, Kleintopsaid. The chances of that happening, however, are about 10% to 15%, he added said.

A long, drawn-out negotiation into next year to resolve issues related to tax hikes and spending cuts isn't going to be the end of the world, but it will keep the stock market volatile, said Bill Stone, the chief investment strategist at PNC Wealth Management.

Remember, the fiscal cliff measures were byproducts of a resolution to the 2011 debt-ceiling fight intended to avoid a credit downgrade -- which happened anyway when Standard & Poor's saw the stopgap plans as not good enough to maintain the United States’ triple-A rating.

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"The best scenario is mixing in some sort of long-term reform into this because then we can avoid this sort of cliff situation again," Stone said.

Even if Congress does nothing and lets all the tax hikes and spending cuts go into effect, it shouldn't hurt stocks that badly, given that higher taxes have not been shown to have a negative effect on stocks, said Brian Belski, the chief investment strategist at BMO Capital Markets.

"The markets are about the economic cycle, not taxes," Belski said. What's missing from the political debate is some sort of tax incentive for businesses to ramp up hiring and capital investment, he said, adding that such an incentive would add to tax coffers by creating more jobs. Such a plan, however, would have to cover three to five years to be useful for corporate planning purposes, he said.

"Overall, the key to this whole thing is to report a conclusion that is crystal clear, recognizable and understandable," Belski said.

Possible losers and winners

Energy companies stand out as being possible losers as some of their tax breaks could disappear, said LPL's Kleintop. By extension, higher energy costs would then be passed along to utilities, he said.

Another possible hit to utilities could be in the area of dividend taxes, given the sector's traditionally high dividend yield rate. If Congress doesn't act, the dividend tax rate is set to nearly triple from the current 15%.

That, however, may be an irrational market reaction to an expected higher dividend tax. The performance of dividend stocks isn't necessarily hampered by higher tax rates, said BMO's Belski, using data going back to 1962 on the top 20% of Standard & Poor’s 500 Index ($INX) dividend stocks ranked by yield.

Industrial stocks may see a boost if tax incentives are part of a fiscal cliff resolution, Belski said. Defense contractor stocks, however, remain under the microscope, according to the strategist, given the billions in automatic military spending cuts in play.

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