Market Preview: Sick of the Cliff?
NEW YORK ( TheStreet) -- Sick of hearing about the fiscal cliff yet? Hope not because the noise isn't about to stop anytime soon.
Like the whole debt ceiling debacle, most analysts don't expect the federal government to actually go over the cliff, a term that refers to the combination of expiring tax cuts and spending reductions set to go into effect in 2013. But again like the debt ceiling debacle, there's the potential for a lot of posturing and angst that could very well bring America much closer to the edge of the cliff than anyone is comfortable with.
And let's not forget, sometimes the unexpected comes to pass; often with disastrous consequences. On Thursday, the Congressional Budget Office, a nonpartisan group, offered up this unpleasant scenario , basically saying that going over the cliff would push the U.S. economy into recession.
"According to CBO's projections, if all of that fiscal tightening occurs, real (inflation-adjusted) gross domestic product (GDP) will drop by 0.5 percent in 2013 (as measured by the change from the fourth quarter of 2012 to the fourth quarter of 2013)--reflecting a decline in the first half of the year and renewed growth at a modest pace later in the year," the CBO's report said. "That contraction of the economy will cause employment to decline and the unemployment rate to rise to 9.1 percent in the fourth quarter of 2013."
That's scary stuff and investors sitting on healthy gains in 2012's equity winners have to be thinking about taking some profits off the table now (if they haven't already), especially since the election's results didn't really provide any sort of referendum.
Capital Economics gave its take on Wednesday, saying it doesn't expect the elections to have a "lasting impact" on the stock market but also acknowledging that the cliff problem will be difficult to navigate.
"Neither the tax hikes on investment income proposed by President Obama nor the tax cuts proposed by his defeated Republican challenger are likely to see the light of day, as Congress remains split," said John Higgins, senior markets economist at the firm. "But a compromise between the Democrats and Republicans to avert next year's fiscal 'cliff' may not be reached until the eleventh hour, which could affect sentiment in the meantime."
Higgins offered up two reasons though why going over the cliff mights not be the end of the world for equities.
"Of course, if the Democrats and Republicans fail to reach the sort of compromise that we foresee, then there could indeed be a major and lasting reaction in the stock market," he said. "But even under this scenario, the impact on the stock market might not be that dramatic for two reasons. First, not all investors pay the top rates of tax that Obama wants to see rise. And second, a growing share of US equities is sheltered from tax."