With the clock winding down and no deal on the table, a legislative impasse is threatening to push the economy over the fiscal cliff. But even as tax hikes and dramatic spending cuts loom, investors have remained cautiously optimistic that Congress will reach a last-minute deal that will, at the very least, cushion the landing on the way down from the cliff.
Talks stalled yesterday as Republicans pressed for use of a chained Consumer Price Index (CPI)—a measure designed to lower the cost-of-living increases that Social Security recipients receive—as a means of achieving spending cuts. As the standstill over the CPI threatened to derail negotiations, Republicans relented and agreed to drop the issue.
With additional negotiations set for this morning, investors are playing wait and see. Futures trading was relatively flat Sunday night, although S&P 500 futures registered a small increase in a sign that investors have yet to give up hope. By mid-morning on Monday, stocks were down slightly across the major indices.
Although legislators are expected to discuss ways to blunt the impact of the so-called sequestration, the name given to the automatic spending cuts set to take effect on Wednesday, investors and politicians alike are resigning themselves to the fact that some details may have to be hammered out after the New Year by the incoming Congress.
Even if the economy goes over the cliff, the new Congress could pass retroactive legislation aimed at pulling out some of the thorns. "The thing to keep mindful of is the new Congress can always make whatever fiddling they do with taxes and spending retroactive," says Marty Leclerc, a portfolio manager at Barrack Yard Advisors in Pennsylvania. "The clock's not ticking toward midnight yet. We probably have another six weeks or so where this horse trading can go on." According to Leclerc, this safety net accounts for the fact that the markets have been "a bit sanguine" even as the cliff approaches.
However, the longer that negotiations drag on, the greater the chance that the market could take a deep hit—a point that President Obama underscored Sunday during an interview with David Gregory on "Meet the Press."
"If you look at projections of 2013, people generally felt that the economy would continue to grow, unemployment would continue to tick down, housing would continue to improve," Obama told Gregory. "But what's been holding us back is the dysfunction here in Washington. And if people start seeing that on January 1st this problem still hasn't been solved, that we haven't seen the kind of deficit reduction that we could have had had the Republicans been willing to take the deal that I gave them . . . that's going to have an adverse reaction in the markets."
Obama pulled no punches as he sought to put the blame for the broken-down negotiations squarely on the shoulders of the Republican Party. "[Republicans] say that their biggest priority is making sure that we deal with the deficit in a serious way," he said. "But the way they're behaving is that their only priority is making sure that tax breaks for the wealthiest Americans are protected."
While daring investors could seek to profit from the mounting uncertainty—for instance, by betting on increased market volatility or by shorting stocks—advisers caution that most individual investors are best served by steeling their nerves and sticking to their long-term plans.
For his part, Leclerc sees a dearth of buying opportunities at the moment, but a pullback in stock prices could lead to some attractive valuations. In the meantime, though, he suggests that investors refrain from micromanaging their portfolios based on new tidbits of information coming out of Washington.
"What's going to happen is either there's going to be a resolution or we're going to go back to the tax regime we had under Clinton," he says. "And the market will move on to a new obsession."