Generally speaking markets are discounting mechanisms. In other words, price action today is discounting what will happen in the future and not indicative of what is happening today. More or less today's price action encompasses future expectations, anywhere from 6 to 12 months at least.
This also means that the market has, to some extent, discounted the fiscal cliff. The market is not going to wait for the fiscal cliff to actually happen to price it in. To some extent it has done that already. And because it is not exactly sure how humans will figure the whole fiscal equation out, it is leaving some room for the benefit of a doubt.
This also means that, while markets might correct from these levels, they might also go up, if, policies chosen to solve the fiscal cliff equation, are to the market's approval.
But because there is no easy fix to the problem (please consider: In A Fiscal Restraint Environment, There Is Nowhere To Hide), the market is cautious and has already priced in much of the problem in today's prices.
Please look at the chart I made below with raw data from S&P.
As you can see from the chart, the P.E. of the S&P 500 index hasn't been this low in 20 years. Also please note that the book value of the index has been steadily going up ever since 2000 - $290 on 12/31/199 vs $639 as of 6/29/2012. The Price/Book has been going lower also - 5.05 on 12/31/1999 vs. 2.13 today.
In other words, the market is not going to wait to see what will happen 40 days from now, but has already taken notice and has already given a preliminary judgment. The market has actually corrected but not in nominal terms. The market has actually corrected in fundamental terms.
In other words it has become very very cheap as a precaution and a way to discount and take into account, what will happen with the fiscal cliff situation.
Markets have not fallen in nominal terms, simply because the fundamentals have gotten a whole lot better over the years.
Now if my logic is correct, this also means that whatever happens in Washington over the next 40 days or so, the fiscal cliff is, to a great extent, backed in the cake. In other words, it is partly discounted for.
This might also mean that even in the worst case situation - in the case politicians managed to really screw things up and somehow make matters a whole lot worse than what they already are - the market might actually not correct much from here. Reason being is that, stocks are already cheap.
I don't have to tell you that Apple (NASDAQ:AAPL) has a forward P.E. of 9, Microsoft (NASDAQ:MSFT) a forward P.E. of 8, Hewlett-Packard (NYSE:HPQ) a forward P.E. of 3.5, Dell (NASDAQ:DELL) a forward P.E. of 5 and countless other stocks that have valuations that many of us could not have believed many years ago.
No I am sorry, I do not buy the argument that Hewlett-Packard is trading where it is because everybody's going to stop buying PC's and that tablets are going to take over. And as far as Microsoft and Apple are concerned, I have absolutely no explanation as to why they are valued so cheap.
My only explanation is that market has not priced in the fundamentals as a way to discount on the down side, for what lies ahead.
So my call is this: unless politicians manage to make a mess of the whole matter, much more than what it already is, the market will not correct much.
Granted there is a negative downward bias in the air and I'm not saying this is a bullish message, but I really think unless they (the politicians) really screw things up, markets will not correct by much and might actually end higher in 2013.