By now you have all read about the details of the Fiscal Cliff deal struck by Congress and the President. It should be glaringly obvious to you that all they have done is to pass what amounts to a Band-aid “solution” kicking the can two months down the road, to March 1st. Republicans have basically allowed the Democrats to win the battle, only to focus their attention on the war to come – the debate over spending cuts and the debt ceiling, both of which must be addressed by the end of February.
Yesterday’s 308-point rally for the Dow, the largest point increase for the Dow in history, was driven primarily by small investors who largely missed the 6%+ gain for the Dow, 12%+ gain for the S&P 500, and the 15%+ gain for the NASDAQ in 2012. These investors really don’t understand what makes markets or the economy tick, and are heavily influenced by the financial media, which has become increasingly focused on short-term trading rather than investing. The result is a complete lack of understanding or acknowledgement of the looming challenges of spending cuts and the debt ceiling, both of which must be addressed between now and the end of February.
One other serious potential blow to the markets is the threat of another sovereign debt rating cut for the U.S. S&P already cut our rating from AAA to AA+. Moody’s has already threatened to cut their AAA rating on the U.S. if the debt ceiling and spending issues are not addressed effectively, or, to put it more clearly, if we don’t come up with a viable solution to dealing with our debt issues while preventing the economy from tanking. Frankly I am not convinced that there is a viable solution that can do both. Even if Congress and the President were in complete agreement and would vote for a solution, I don’t think there is a solution that will accomplish both controlling debt and preserving economic growth.
I sold more stock positions yesterday and maintain a cautious stance regarding equities. I also recommend shorting bonds,e specially longer maturities. There are a number of ETFs available for this purpose. Bonds are in a bubble, and will very likely start to collapse in 2013. They are being held up at artificially high prices due to government actions – twisting (selling short maturities and then buying long maturities with the proceeds), and quantitative easing -printing money and buying long maturities. These actions will have to end at some point, and when they do, or perhaps even before they end, bond prices will start to fall. Those holding long maturity bonds should think long and hard about the risk in these securities.
The new Congress goes into session today. Democrats maintain the Senate, picking up 2 seats, and Republicans maintain control of the House, losing 2 seats there as well. In other words, nothing has changed in terms of control, setting up the same kind of contentious debate that we have seen consistently with all major issues under debate. The next two months will offer lots of volatility in the financial markets, and good opportunities for those with cash to take advantage.