As we approach year-end, equity markets are at the mercy of the rumor mill and the comings and goings of politicians. Throughout the entire day, financial television speculates on the outcome of the political tug-of-war that is the fiscal cliff. Clearly, nobody–not even the main political actors–knows how this will unfold. So I won’t weigh in with needless speculation. The resolution will, however, have significant short-term effects on market prices one way or the other.
Far more important will be the long-term effects. It’s essential to recognize that there are no easy solutions and that all alternatives bear a considerable amount of pain. As has become increasingly clear, the U.S. has rung up greater debt and promises than it will ever be able to meet in dollars worth anything resembling the value of the dollar today. The rating agencies know that better than anyone else. Should the ultimate fiscal cliff agreement fail to reduce deficits and debt significantly, undoubtedly the ratings on U.S. federal debt will again be reduced. While the first debt downgrade had little negative effect in the marketplace, further downgrades will eventually make it more difficult for the U.S. to float and service its debt.
Should politicians surprise us all by crafting a deal that makes meaningful dents in projected deficits, almost certainly large segments of the U.S. population will end up paying substantially more in taxes. Additionally, large amounts of government spending will almost inevitably be cut back. The combination of those two factors will inhibit Gross Domestic Product growth for years.
By spending more than we have produced for three decades, we have painted ourselves into a financial corner from which there is no comfortable escape. The open question is what path we will take and what consequences that will entail.
When the chosen path becomes clearer, there will be a plethora of subjects to address. I will attempt to identify and clarify those with the greatest implications for investors.
Until next year, I wish you all a very Happy New Year.