How The Looming Fiscal Cliff Has Created The Looming December-January Stock Market

Includes: DIA, QQQ, SPY
by: David Bader

The fiscal cliff is the latest in a series of stock-market-affecting economic crises. There was the housing bubble. That resulted in the great financial crisis involving the banking system as well as the associated near demise of the entire American automotive industry.

The purpose of this article is not to be a Monday morning quarterback in order to try to explain what caused these events to happen. There have been countless articles that have already done that. This article is also not about assigning blame or even about identifying how they could have been avoided.

Rather, it is to remind investors that events like these have a profound affect on the behavior of many stock market investors (both institutional as well as individual). This is because each of these events create a great deal of uncertainty. And, if the stock market were Superman, uncertainty is the equivalent of Kryptonite. For those who prefer to play the role of Monday morning quarterback, many have analyzed these "Kryptonite" market reactions and have identified many of them as overreactions that balance out in the log run.

So, that brings us back to the looming fiscal cliff and that little word... uncertainty. Much of the uncertainty this time around is not about whether or not a solution is in the works. Everyone involved in trying to avoid the fiscal cliff admits that going over the cliff will be detrimental to the U.S. economy and, thus, to the stock market as well. As a result, all who are involved know that a compromise must be reached. Once again, the point of this article is not to identify who has the better plan to avoid the fiscal cliff. Neither is it about commenting on political posturing or presidential mandates. Rather, it is to identify that, just as was the case with the financial crisis, the stock market could be greatly affected until compromise and the resulting solution lead to ridding ourselves of uncertainty.

Specifically, if the fiscal cliff issue is solved sooner, rather than later, the stock market may avoid going through a roller coaster December and January. But, the reverse is true as well. That is, if a solution is found only as the deadline is very close or even after the January 1st deadline has passed, the stock market could see a very volatile December and January.

Why is this? It's simple. It has been widely advertised that the fiscal cliff could cost all American families a minimum of $2000 on an annual basis in taxes if Democrats and Republicans can't get together to do their jobs on behalf of the American people. And, since both parties have now had a long history of not working together (even when America's credit rating was at stake), who can blame anyone invested in the stock market for pulling funds out in order to err on the side of safety. After all, every American family must look at their potential $2000 tax increase as money that they probably should not spend this holiday season. And, since we know that a large percentage of retail sales occur in December and, further, that retail sales comprise the largest component of GDP, those December purchases being withheld by the consumer would translate into lower profits and into lower stock prices.

Some have been tempted to point to positive sales figures for Black Friday and Cyber Monday to try to extrapolate a successful 2012 holiday shopping season. But, we have all heard about positive Black Fridays in years past that did not translate into huge final holiday figures. In fact, I would argue that it is entirely possible that great sales numbers on Black Friday and Cyber Monday are caused by hyped-up advertised specials by retailers for these days and may mean that great numbers of dollars spent on those days mean less dollars available for people to spend the rest of the season.

How will this fiscal cliff negotiation stuff pan out? I have no more of a crystal ball than anyone else. I do, however, have an opinion based on political lessons from the past. Again, without regard to placing blame, it seems to me that Republicans will not be willing to vote for any tax increases (even on only the top 2%) before the January 1st deadline. Instead, after January 1st hits and taxes go up on everyone, their vote to compromise then can be spun as voting for tax cuts for 98% of Americans. They can claim to have only voted for tax cuts and not for tax increases.

My non-crystal-ball guess, therefore, may lead to the roller coaster December and January that I spoke about. Of course, as is always the case, for longer term investors, the fiscal cliff is only a speed bump. There will be an answer to the fiscal cliff. There will be a solution to the budget challenges cased by social security, Medicare, and other entitlements. Will these solutions be perfect? No. But, they will bring about less uncertainty.

Finally, there is a silver lining to this potential dark cloud. If holiday dollars go unspent in this holiday season because of the uncertainty of everyone's taxes going up starting on January 1st and my non-crystal ball scenario does play out, those dollars will be spent in the quarter ending 3/31/13. This will lead to positive sales and GDP comparisons to lead off the new year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.