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Where Is The Happy Ending? Part 2

Earlier, I posted a discussion on looking beyond the current troubles and making investment decisions based on the probabilities of success in the bond and stock markets. In this post I will cover the current troubles and their long term investment implications.

As I write this, there are two major concerns among investors. The Fiscal Cliff and Europe are on most investors' minds. First, let me dismiss Europe. European countries are headed into recession. Many experienced retraction in production in the third quarter. Notably, Germany is slowing though not yet contracting.

The US economy is affected by these slowdowns in Europe. US companies are affected by this slow down in two ways; first and most obviously, by exports. Exports to Europe amount to 0.5% of US GDP, so an (unlikely) drop of even as much as 20% in exports would reduce US GDP by only 0.1%. The second effect is found in the reduction of US company sales in Europe from European-based facilities. This is not minor to the companies involved, but the effect on the US economy is very small. For example, suppose a car company makes and sells a car in Europe. Its profit will be only a small portion of the sales price, and the amount it sends back to the US a further reduced portion. If a thousand of those cars didn't sell because of reduced European demand, it would make very little difference to the American company, or to the American economy. The third consideration: Europe is very close to an economic bottom, and any effects on our economy are already passing.

The fiscal cliff crisis, as the name implies, is a much more dangerous prospect. The government directly or indirectly spends a quarter of every dollar spent in our economy. The federal government is the economy's best customer. A large reduction in federal spending, or a large reduction in consumer spending caused by a tax increase, will slow our economy. The slowdown may be enough to start a recession. Several factors can make this cliff into a navigable "steep grade". First, the congress and president will prevent the cliff -dive by passing a compromise bill. Second, the cut-backs would come in the form of reduced spending all year, effectively distributing the pain. Third, investors should not try to bet on unknowable outcomes.

The Fiscal Cliff will be resolved this year, or it won't. Betting your portfolio on one outcome or another is speculation. If there is no resolution, then we will have a recession followed by a 2014 recovery; money lost in the stock market in 2013 will be substantially recovered in the next few years. This will not solve the whole problem, but it provides a much more positive backdrop for the future. With a resolution, we should see a relief rally in stocks, followed by a sluggish economy and market as we struggle with our huge debt and deficit. Either way a long-term-oriented portfolio should be fine. This happy ending may come, as do all the best happy endings, after a period of suffering and angst.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: © Regions Bank, Member FDIC. The foregoing represents the opinions of the author, Brian Sullivan, and not necessarily those of Regions Bank or Regions Investment Management, Inc. (RIM). RIM provides commentary to clients of Regions Bank, an affiliated company wholly owned by Regions Financial Corporation. The information contained in this report is based on sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This report is designed to provide commentary on market strategy and the opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice. The author may or may not own shares of specific securities mentioned within this report. RIM assumes no responsibility or liability for any loss that may directly or indirectly result from the use of such information by you or any other person. Investments discussed in this report are not FDIC-insured, not deposits of Regions Bank or its affiliates, not guaranteed by Regions Bank or its affiliates, not insured by any government agency, and may go down in value. Investment advisory services are offered through RIM, a Registered Investment Adviser. RIM is wholly owned by RFC Financial Services Holding LLC, which in turn, is a wholly owned subsidiary of Regions Financial Corporation.