"A merry heart doeth good like medicine." - King Solomon
Markets continued to gain independent of the made-for-TV drama known as the Fiscal Cliff. Better economic data continues to push investors into more cyclical areas of the equity market, with small-cap and emerging market stocks continuing their broad outperformance. It appears that markets are now numb to the incompetence coming out of Washington, and continue to fight higher despite ongoing skepticism. On CNBC Friday, I called this the Rocky Balboa stock market because despite hit after hit from the bears, the S&P 500 (NYSEARCA:SPY) is on track for its best year of performance since 2009.
Can the Fiscal Cliff derail the uptrend in risk assets? While possible, the reality is that the combination of tax hikes and spending cuts may, in actuality, have little impact on the stock market in the face of continued stimulus from worldwide central banks and a recovering Europe. The S&P 500 in 2012 has increased by over a trillion dollars in market cap alone through the advance, which is more than the Fiscal Cliff's anticipated hit to the economy in 2013. While tax hikes would be detrimental to the American consumer, the market itself seems considerably more immune to it. That appears to be the message of price right here, right now.
Our ATAC models used for managing our mutual fund and separate accounts remain in equities, and have performed quite nicely in the face of pundits calling for a bear market. The media seems to glorify those who are overconfident in their extreme negative views, rather than those who have actually been right and are respectful of price action. Conditions dictate the likelihood of stocks outperforming bonds and vice versa, not the narrative of the Fiscal Cliff and Europe. The conditions that matter most are the direction of inflation expectations, and to that end, it is those conditions that nudge risk-taking behavior. Because price follows actions and not words, it is price that dictates true expectations about the near-term direction of markets.
While I have no insights on Washington beyond what I read in the papers (or rather on the Kindle), I suspect a small deal will get done next week just in time for the New Year. Never underestimate the power of Washington to procrastinate but get things done right before a project is due. Granted, the quality of that project may not be great, but at least it gets done. For markets, it may be just the thing needed for Rocky to land a haymaker into 2013.
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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. I have no business relationship with any company whose stock is mentioned in this article.