Despite daily warnings about the effects of the fiscal cliff -- tax increases and budget cuts that could cripple the economy -- the markets seem supremely convinced that all will be fixed before the Dec. 31 deadline.
"The markets are assuming that a deal is still likely to save the day," says Alec Young, international analyst for Standard & Poor's. "If they thought nothing would be done, the markets would sell off badly."
But if you look closely enough, you start to see the markets' calm facade starting to crumble. While most analysts say they're convinced Congress will avert causing another recession, every day brings growing uncertainty. Just how long Congress can drag out the talks before a big sell-off in stocks and commodities is the big unknown.
At first glance, the financial markets seem exceptionally calm, given the potentially calamitous fallout from the so-called fiscal cliff. Since the Nov. 6 elections, the Standard & Poor's 500 has fallen 1 percent. Treasury yields have barely budged. Even gold is up less than $10 an ounce.
The markets seem to have, at least at the moment, a deep and abiding faith that Congress will work things out. "People believe that there's already a secret deal that will be put through at the 11th hour," says Jeffrey Gundlach, portfolio manager and CEO at DoubleLine, a Los Angeles bond management firm. The current buzz is that Republicans and Democrats will agree to raising taxes by half the amount the president has proposed.
Exactly why the markets believe this is puzzling. House Speaker John Boehner, R-Ohio, at a press conference Friday, said, "This isn't a progress report because there's no progress to report."
One reason markets remain confident: Investors don't want to miss a potentially huge rally if Congress and the president come to an agreement and avoid falling off the cliff. Absent the fiscal cliff, the stock market looks reasonably good: Corporate profits are high, company balance sheets are solid and consumers have an enormous amount of pent-up demand.
Another reason: "For now, the markets aren't that worried about the fiscal cliff debate, because they have had bigger fish to fry," says Rob Haworth, senior investment strategist for U.S. Bank Wealth Management. One example is the November employment report, which showed the unemployment rate falling to 7.7 percent from 7.9 percent in October. And signs of a turnaround in China, for example, have kept the stock market's spirits relatively high.
A Wile E. Coyote moment?
Should the financial markets have a Wile E. Coyote moment -- the point when the hapless predator realizes he has walked off a cliff -- they, too, could plummet. Consider what happened when Congress balked at raising the debt limit in 2011. The S&P 500 plunged 16 percent in 11 trading days, culminating in a 6.7 percent decline after Standard & Poor's downgraded the nation's credit rating for the first time on Aug. 5, 2011.
And there are a few signs of cracks appearing. "We're starting to see a more volatile trading pattern indicative of investor nervousness," says Jim Russell, senior equity strategist for U.S. Bank Wealth Management. For example:
The VIX, the so-called fear index of volatility, tends to rise when politicians make announcements about the fiscal cliff, Russell says. The VIX soared during the debt-limit debate in 2011.
Utilities stocks have lagged. Investors prize electric utilities stocks because they pay higher dividends than most other members of the S&P 500. But those dividends will be taxed at ordinary income tax rates if Congress doesn't renew the George W. Bush-era tax cuts. The Dow Jones utility average has fallen nearly 5.5 percent since Oct. 31, while the S&P 500 has been virtually flat .
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