“Fiscal Cliff Dodged.” This is the type of headline seen on nearly every major news source on January 2nd. Equity markets reacted favorably, rising well over 2% after the announcement that the American Taxpayer Relief Act had been passed by the U.S. House of Representatives. Many people would agree that avoiding the “Fiscal Cliff,” a set of mandatory tax increases and spending cuts set to take effect on January 1st, was a good thing for the U.S. economy, but what does the passage of this bill really mean? The deal signed by lawmakers is, in reality, only postponing the proposed cuts for two months. At some point, near the end of February, we are set to come up against the debt ceiling again, likely sparking another contentious debate over the federal budget (for a more specific look at the bill, see our recent blog post: [ilink url=”http://wp.me/p328Ak-GB”]Tax Consequences of the “Fiscal Cliff” Deal[/ilink])
If the bill that was passed is, in essence, more symbolic than effective in avoiding the cliff, why did the market react so positively? The media has one main focus, and they are well aware that attention grabbing headlines about dire market consequences are an excellent way to promote viewership. With this in mind, financial websites and other outlets will emphasize market “uncertainty” as much as possible. For example, the financial media was full of negative news about the world economy last year, but global stocks still delivered in excess of 16% in 20121. It is important to remember that while markets are often seen as an omniscient entity that efficiently internalizes all new information, they are largely driven by a collection of investors who are subject to the same emotions and biases as anyone else. By postponing any real decisions on the debt ceiling, we are left with what the markets like least: uncertainty. As investors deal with the uncertainty of a government that has been unable to reach an agreement or compromise on how to tackle the budget deficit, markets are likely to become increasingly skittish, particularly as the next deadline approaches. While this can be intimidating for someone who watches the value of their portfolio change day-by-day, a prudent investor will trust the fundamentals of their investment strategy and ignore market noise as much as possible.
1 As measured by the MSCI All-Country World Index