10/22/2012 8:45 PM ET|
Will US stocks fall off fiscal cliff?
Analysts are raising their predictions for the coming year. But if the scheduled tax hikes and spending cuts prove imminent, overseas assets could be the place to be.
In recent days, you might have noticed that Wall Street analysts have been raising their predictions for 2013.
With the Standard & Poor's 500 Stock Index ($INX) near its 2012 high at 1,460 on Oct. 18, analysts had been calling for the index to challenge its all-time high of 1,565 -- set in 2007 just before the global financial crisis -- next year. Following the stock market's long tradition of making most investors look like idiots most of the time, the S&P 500 dropped by 1.7% the next day.
What I find oddest about these predictions, though, is not that they're necessarily wrong, but that they ignore the facts of life in the financial markets for the last two-plus years -- and one big factor you'll need to watch closely that could take U.S. stocks out of the next move up.
Correlation and the fiscal cliff
The predictions I've seen put prospects for earnings growth at 7% to 11% in the fourth quarter of 2012, which, following a decline in earnings in the third quarter, would set up the market to move ahead in 2013. Or they foresee continued low interest rates from the Federal Reserve and the extra liquidity being pumped into the economy and market by the Fed's most recent program of quantitative easing. Or they argue that although the price-to-earnings multiple on the S&P 500 has climbed to 13.3 from 12 at the beginning of 2012, there's still room for further advances because the multiple at the peak in 2007 was 15.2.
All those observations are true, but they've been beside the point recently. What's oddest to me about these predictions is that so few take into account the peculiar macro-driven nature of the financial markets over the past couple of years. Since basically the spring of 2010, when investors around the world started to focus on the possibility that Greece, Ireland, Portugal and others were facing default, financial markets have been dominated by big macro trends.
And that has meant that they've moved in startling lockstep -- what the market calls "correlation."
This means that the most important question for you now as you set up your portfolio for the coming year isn't whether the U.S. market might move up 9.2% by the end of 2013. It's whether this lockstep period might be coming to an end and whether, in 2013, other markets might be able to rise even when the U.S. market doesn't, or at least outperform a decent U.S. market.
You'll recognize the pattern I'm about to describe. After all, we've lived with it for roughly two years.
When fears about the eurozone flared, global assets moved toward "safe" havens in the United States and Japan. To investors trying to hedge their risks, the effects could be disconcertingly widespread. A stronger dollar, for example, could lead to a price drop in commodities (and commodity stocks) and even produce a retreat in the price of gold. Gold, an asset purchased to hedge against financial turmoil, falling because of financial turmoil? Go figure.
When it looked like one plan or another might succeed in heading off the eurozone crisis, European stocks and bonds would rally. And so would other risk-on assets, such as stocks in emerging markets.
Add in such macro drivers as fears of a hard landing in China or a slowdown in U.S. economic growth, and you don't change the story -- the price of assets still determined by macro trends -- even if you make it more complicated.
I don't see how any analyst can make a prediction for 2013 without taking the macro-driven nature of the past, current and, I'd argue, near-term future market into account. Global cash flows, major drivers of asset prices, are nervously trying to figure out the risk and reward of stakes in specific markets and asset classes. The money that flowed into U.S. markets as investors sought a safe haven during the eurozone debt crisis has been a major factor in driving up the prices of U.S. stocks and bonds in 2011 and 2012. A reversal of those flows would act as a brake on U.S. asset prices and encourage the appreciation of assets in the markets receiving those flows.
Macro trends won't be the only determinants of asset prices in 2013, but decisions about allocations among markets and asset classes need to take our best projections of those macro trends into account.
To unravel those trends, and to get some insight into how markets are likely to be in the rest of 2012 and in 2013, I think the looming fiscal cliff in the United States is the place to start.
U.S. at the cliff's edge
One of the most striking things about recent predictions for 2013 has been the assumption that the U.S. just won't drive off a fiscal cliff at the end of 2012 or at the beginning of 2013. Politicians in Washington, Wall Street assumes, won't be so stupid, self-destructive and shortsighted as to let a combination of the expiration of the Bush tax cuts, the end of the reduction in Social Security taxes and the imposition of automatic budget cuts send the U.S. economy back into recession.
I think the most likely outcome is indeed some kind of deal that prevents the U.S. from pulling a Thelma and Louise. But we can be assured that the process won't be easy, smooth or quick. There will be moments when a deal appears to be just around the corner and moments when it seems impossible. We know from the long-running cliffhanger that is the eurozone debt crisis that the cumulative effect of this kind of melodrama is a gradual increase in nervousness and fear. Also throw in, as I think we should, a couple of warnings from Standard & Poor's and Moody's Investors Service about possible downgrades to the U.S. AA credit rating and some posturing by partisans on the Democratic and Republican sides. (The latter scenario is extremely likely if President Barack Obama wins re-election and some Republicans decide it's their job to make sure his second term doesn't succeed.)
Given all that, it's hard to see why investors would be willing to award the United States automatic "safe-haven" status.
How big any gradual diminution of the "safe-haven" premium will turn out to be over the next two quarters or so will depend not just on what does or doesn't happen in the United States, but also on how macro trends unwind in both Europe and China. Remember that the market's vote of confidence in the United States hasn't been a vote for the absolute quality of U.S. fundamentals, but instead a judgment on the relative quality of those fundamentals versus the eurozone and China.
So if the squabbling in the U.S. over a solution to the fiscal cliff rises in volume at the same time that the eurozone and China look relatively less risky, we could see a fairly high flow of investment cash into European and Chinese financial assets.
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There will be a last minute agreement like last year that nobody is really happy with.The
congress is noy going to miss their well deserved Christmas vacation.I`m sure that`s
what everybody is worried about.
What ever you're smoking I'd like to get some!
So we are betting that Politicians won't be so stupid? Holy smokes, I need more Guns & Gold, Lemme see, how stupid can politicans be? They steal Postage! They jump in the Yaught Basin with hookers, They grab the leg of the guy in the next toilet. They declare that a **** is not sex and they did not have sex with that women. They think there are 57 States. Here, in Jersey they crash cars at High speed and have sex with truckers at the NJ Turnpkie rest stops.
C'mon Jim, Politians can be plenty stupid, and when time runs out and they can't kick the can any further down the road and the can falls over the fiscal cliff, I think we are going to see records set in Stupid that belong in the Guiness Book of Records.
In the mean time I'll stick with Gold & Guns, as well as quality stocks paying increasing dividends covered by earnings in Oil, Commodities, Food, Water and a wee bit of Tech.
We are going off of the cliff and that will not be so bad. It's the landing that will kill us.
In recent days, you might have noticed that Wall Street analysts have been raising their predictions for 2013.
TRANSLATION: Christmas/end of year is coming and I want to increase my bonus.......and you know I wouldn't lie right??
It's the normalcy bias so obvious in these "fiscal cliff" scenarios that I find amazing. Always told from the standpoint of "If I tell a lie, may God strike me dead." Well, we all know how that ends up.
God's existense has become a straw man argument.
Even if you get away with it, like this country has by not addressing the real problems. The problems don't go away, the consequences of not dealing with them just gets worse. This is because things do change whether you're inclined to worry about things actually getting worse or not.
Mr. Jubak here says how the U.S. will not be facing anything like a "Thelma and Louis" event if our dysfuntional government really does take the country over some "fiscal cliff." That attitude was not okay the first time, when the country still had a AAA credit rating. That attitude is even more inexcusable with the truly untested AA credit rating the coutnry now has. If you don't live responsibly, sooner or later, lightning does strike back.
Every American has seen this happen at least once in their life, even after abject apologies for almost destroying the country have been offered, and promises that the same thing will never ever happen again are made. The truth is that the country hasn't learned anything. And what about the lightning? It's on the side of Thelma and Louis.
When articles about China are outlawed, only outlaws will have articles about China.
I just finished George Carlin's memoirs "Final Words." All things considered, I'm inclined to drink myself to death.
We may have democracy, or we may have wealth concentrated in the hands of a few, but we can't have both.
KOO: Why in the world bring the wives into it??? Can't you stick to the issues or do the issues impact your choice of president negatively? And the only thing you can come up with is diss the wives? Pretty shallow and desperate thinking IMHO.
AS LONG AS RATES ARE AT ZERO SO WILL GROWTH.
THE RATES ARE NOT LOW FOR JOB CREATION.
THE FED'S BANKER BUDS LIKE IT THIS WAY!
TEN YEAR'S OF CHEATING SAVERS HAS CUT SPENDING THAT DRIVES OUR ECONOMY.
SENIORS HAVE SPENT THEIR PRINCIPLE / THEY WILL NEVER GET IT BACK / THEY WILL NEVER SPEND LIKE THEY WOULD.
THIS IS THE COST OF CHEATING THE SYSTEM WITH THESE UNGODLY LOW RATES.
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The final week of August represented one of the quietest stretches for the stock market so far this year. The first four sessions of the week produced the ... More
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