Why Markets Don't Fear The Fiscal Cliff

MSN Money May 8, 2012

5/7/2012 2:00 PM ET

By Jim Jubak

The tax hikes and spending cuts scheduled to kick in at year's end could wreck the economy. So why isn't Wall Street sweating?

The fiscal cliff approaches. Everyone in the vehicle knows it is there. Everyone in the vehicle knows that plunging over the fiscal cliff would send shock waves through the U.S. economy and stock market. Everyone knows the odds of avoiding the plunge are extremely low. And everyone can put a date on the plunge.

Is the only question when to jump out of the car?

The U.S. fiscal cliff sits on the horizon at the end of 2012.

A perfect storm of pending tax increases and spending cuts -- all automatic unless politicians in Washington move to stop them -- would cut growth of the U.S. gross domestic product in half in 2013, according to the Congressional Budget Office.

If politicians stop the tax increases and the automatic budget cuts but do nothing to reduce the resulting deficit -- which is frankly the most likely outcome if Washington does anything at all -- GDP growth would pick up and unemployment would fall in 2013.

But deficits would soar and the percentage of debt held by the public would climb to the highest level since the end of World War II. The U.S. could expect further credit-rating downgrades from companies such as Standard & Poor's, a weaker dollar and rising interest rates, which would all cut long-term growth.

Jim Jubak

A pretty set of alternatives, no? Let's sketch in a few more of the grisly details.

Here's how the Congressional Budget Office summed up the approaching fiscal cliff in January.

What the CBO calls "tax provisions," and that most of us think of as the Bush tax cuts, are set to automatically expire at the end of this year. That would boost individual income taxes by $3.8 trillion from 2013 through 2022.

The Alternative Minimum Tax isn't indexed to inflation, so with rising inflation, more and more taxpayers face the higher rates of the AMT. Congress has passed a series of one-year patches that have essentially increased the income level at which the tax hits. Without that fix -- and no fix has yet been passed for 2012 -- the Congressional Budget Office projects that the number of taxpayers subject to the AMT will go from 4 million in 2011 to 30 million in 2012.

Should the Bush tax cuts expire?

The automatic spending cuts put in place as part of the debt-ceiling compromise are to go into effect in January 2013. The spending cuts amount to $103 billion a year. The cuts to Social Security withholding taxes, enacted as part of the Middle Class Tax Relief and Job Creation Act of 2012 in February, expire at the end of the year, sending the withholding rate back to 6.2% from the current 4.2%.

The total, if all the automatic cuts and tax increases happen, would remove about $500 billion, or 4% of GDP, from the U.S. economy.

The effect, the CBO estimates, would be to reduce GDP growth from 2% in 2012 to 1.1% in 2013. Cheeringly, the Congressional Budget Office estimates that economic activity would "remain below the economy's potential until 2018." Unemployment would stay above 8% in 2013 and wouldn't decline to 7% until the end of 2015.

The bad news is that the CBO forecast falls at the optimistic end of forecasts. Some economists calculate that tax increases and spending cuts of that magnitude would cost the economy about 2.8 percentage points of growth. Subtract that from the 2.2% annual growth rate recorded by the economy during the first quarter, and you get a negative number.

In other words, these tax and spending cuts could push us into recession again (the negative view) or give us an economy growing at just 1.1% (the positive view). That wouldn't be a recession, technically, but it would feel like one.

What, markets worry?

Are the financial markets worried about this? We're certainly starting to hear a lot of talk about the "fiscal cliff." For example, on May 3 the Washington Post published a piece by Mohamed El-Erian, co-chief investment officer of bond-fund giant Pimco, warning about the fiscal cliff and urging Washington to get with the program.

But I don't think that fear of the fiscal cliff is yet manifest in the stock market. The drop last week -- 33 points or 2.4% on the Standard & Poor's 500 stock index ($INX) -- was a result of worries about near-term U.S. economic growth and near-term U.S. job growth and near- to midterm recession in Europe. If investors had focused on the fiscal cliff, the damage would have been much more severe. In fact, I'd say, at this point the near-term decline in stocks is likely to be limited by optimism over higher economic growth in the United States in the second half of the year.

Part of the reason for the lack of worry about a fiscal cliff is that it's too far away. The stock market is notorious for its inability to think more than about six months ahead. It's only early May -- too early to worry about January and way too early to worry about an economic slowdown that would only gradually build up speed in 2013.

Fund mentioned in this article: Jubak Global Equity Fund (JUBAX).

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It's pretty much common sense...in general terms spend less, take in more. We need to take the pain now....EVERYONE!

All sectors of spending must be trimmed and looked at with common sense regulations. Some military spending should possibly be shifted to homeland security...keeping the Governmnent money in the US. Those riding Harley Davidsons and using smart phones should not be on Welfare programs...they need to get a job. The list can go on and on...I'm just saying use some common sense. and START paying down the debt! Oh and by the way, discontinue the lobbying.

7 0ReportSpamJust enter your preferred display name below3 hours ago

There is no fiscal cliff.

Bernanke can just do what Buzz Bernanke does best and that is print monies to infinity and beyond.

I say the government drop all taxes income,social security,state sales tax, property tax and pay for things the way they were meant to be paid for.

WITH TOTALLY FREE monies printed by Bernanke.

After all he is paying for more of the tab now than the US taxpayer so why not let Bernanke pay for it all. After all he just has to print more money and in this day and age he doesn't really have to print money. It just appears in the bank accounts as if by magic. You need $5 trillion to jump start the economy. Poof there it is a simple computer addition to the balance on Bank of the America's CEO account. It when from $2 trillion to $7 trillion over night.

Magic. Why worry about money it's all just fake money and Bernanke and make it appear in any bank account across the world with a couple of key strokes.

Do you know what Bernanke's productivity factor is??

It takes 63 million people all year to make $1 trillion dollars.

Bernanke and make $12 trillion in just 12 seconds.

With productivity like that Bernanke can save America.

3 0ReportSpamMM23 hours agoThe perfect storm....i love this financial soap unfolding....so easy to see.....scrambling, scrambling to gold and silver....those that get there first will be happy they did. 2 2ReportSpamhavasu464 hours ago Since when is raising taxes to pay our bills a fiscal cliff. The real fiscal cliff is to keep borrowing money now to create a false sense of security and success while running up a debt like those of the PIGS. The GDP is not really growing if the numbers are inflated by more borrowing so Wall Street has more US debt to minipulate. Wall Street in drunk of false numbers created by the FED and US Congress playing with reality. Let's raise taxes and pay of a bunch of debt so in 6 or 7 years we can start the process all over again. 2 1ReportSpamusual suspects5 hours agoThey're not worried because nothing will happen. The fix is in!! 4 0ReportSpamMasasar6 hours agoDon't trains always crash in slow motion? 0 0ReportSpamCrying Tree7 hours agoThe national debt will be cut in half by the end of his first term. Looks like its close to triple. I just can't stand promises from people who want to be president that are less than truthful. The stock market & precious metals have ruled financially for a long time. Housing and inflated cash have been in the gutter. Both of the first two have been over bought ( stocks & metals). The cliff's edge is coming close as housing & cash are still worth less. 11 2ReportSpamZEEBART9 hours agothe stock market looks ahead 6 months ya right they are lucky to look ahead 2 hrs . with the computer systems of today they wheel and deal by the min . until we have have real people in top positions with common senise and without the disease of greed . nothing will likely get better the hole has been dug . 12 0ReportSpamcomsense17 hours agoThe current white house occupant a sure progressive left wing spender will be lame duck with either a victory or defeat. The 2 months this occupant will serve if defeated and the 2 months of a lame duck legislative branch will set up the country for one of the most misguided periods in our nations history. Either scenario doesn't paint a rosy picture. If the white house occupant wins in Nov. he will be lame duck anyway....he and a less than conservative legislature will BALLOON the debt and cause pain in the later part of this decade much worse than the great depression. The only way out of this mess is to slash spending sharply, and increase taxes. If we take the pain now it will hurt, if we wait and put off treatment our fate is not a good one. 21 22ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment?/**/ DATA PROVIDERS

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Fund mentioned in this article: Jubak Global Equity Fund (JUBAX).

Why Markets Don't Fear The Fiscal Cliff

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