NEW YORK - Will all the hand-wringing over whether the U.S. economy will crack if it falls off the "fiscal cliff" put the brakes on the stock market's traditional post-election rally?
"In a word, 'yes,' " says Barry Knapp, head of U.S. equity portfolio strategy at Barclays Capital.
The fiscal cliff is the obstacle confronting Wall Street in the wake of U.S. elections. The term fiscal cliff refers to the potential economic fallout that could occur if Congress doesn't act to stop the coming tax hikes and government spending cuts set to kick in Jan. 1. If the roughly $600 billion fiscal drag isn't avoided, it will cause the U.S. to fall into recession next year. Wall Street is particularly worried about the potential hike in taxes on stock profits and dividends, if the Bush-era tax cuts are allowed to expire.
Despite suggestions from President Obama and House Speaker John Boehner, R-Ohio, on Friday that they are willing to compromise to strike a deal before the year-end deadline, Wall Street is skeptical. Many analysts don't expect a resolution until the 11th hour. No doubt, weeks of continued uncertainty will do little to bolster investor confidence or risk-taking.
"We expect no significant reduction in public policy uncertainty, which shifts the risks to the downside for stocks and other risky assets," says Knapp, adding that investors are just now factoring into the market the possibility of tax rates going up on stock profits.
The cliffhanger could chill a normally bullish time for stocks, notes John Higgins, an analyst at London-based Capital Economics. The period from Election Day through year's end has been investor-friendly over the past 50 years, with the Dow Jones industrial average posting positive returns 61% of the time in those time periods and gaining 1.2%, on average.
The Dow has already fallen more than 400 points since the election as attention shifted to the looming negatives of the fiscal cliff. Higgins expects stocks to struggle "until a compromise is achieved."
Ann Miletti, lead portfolio manager for Wells Fargo Advantage Funds, also believes the final months of 2012 could be "rocky" for stocks.
"Usually the end of an election brings certainty and optimism, but this time it is different," Miletti says. "With the House controlled by the Republicans, the Senate controlled by the Democrats and President Obama back for four more years, we may back to the same stalemate position we have been in."
Miletti also expects companies to put hiring and spending decisions on hold until they get a clearer picture on what tax policy might look like and what the rules of the game will be going forward.
Says Miletti: "It's tough to see a rally in the short term without more certainty as it relates to the fiscal cliff."
Walter Zimmermann, chief technical strategist at United-ICAP, points out that stocks failed to rally following the elections in 2008 and 2000.
"A post-election (rally) is far from assured," he says.
Adam Shell, USA TODAY