The “Fiscal Cliff”… A Reality Check

Posted on November 16, 2012
Filed Under Investor Mistakes, Mutual Funds, Personal Investing, The Economic Scene

For months, you’ve been hearing about the “fiscal cliff.” Specifically, $500 billion in tax increases and across-the-board spending cuts are scheduled to take effect after Jan. 1 unless President Obama and Republicans reach a new deal to reduce the deficit.

The political parties created the deadline last year as a way around their debt-ceiling impasse. The phrase itself, ironically, was coined by the normally low-key Fed Chairman, Ben Bernanke.

That $500 billion equals roughly 3% to 4% of gross domestic product. The Congressional Budget Office has said the result would be a short recession, though some analysts say the measures could be managed so they do less damage. “Slope,” they argue, is a better metaphor than cliff.

If the talks fall apart, the stock market would take a hit, but the economic fallout wouldn’t be instant. It would be spread out over time. Of course, the whole scenario will be avoided if our elected leaders reach a deal by year’s end. (And I think they will, at the last possible moment.) But what if they don’t?

Again, despite what the doomsayers tell us, the economy wouldn’t drop like a rock. Instead, we’d start rolling down a fiscal hill. And here’s the key point—at any point on that trip down the hill, legislators could, and presumably would, make a retroactive deal that would stop the descent.

You can be sure of this – the debt negotiations will play out as political theater, with plenty of hard-nosed speechifying from all sides. But since the presidential election, there has been at least a modest shift in the political rhetoric, with a little less saber rattling and a little more talk of compromise. That’s promising.

A deal, however imperfect, seems probable. As Wall Street Journal columnist David Weidner recently wrote, “The most likely outcome is a combination of tax increases, spending cuts and kicking the can down the road.”

So how should we as investors react to this drama? Two ways.

First, it should remind us about the tendency of politicians and the news media to create unwarranted hype. Both these groups keep referring to a “cliff,” even though most of their members know that the analogy is probably a bit over the top.

Second, remember that the best time to buy is when others are selling. We do expect a frothy market over the coming weeks. Putting new money into your Fidelity mutual funds during a market dip could likely turn out to be a wise move.

 

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