Fiscal cliff “deal” doesn’t deal with real issues at all!

Boy, was this holiday season volatile for the capital markets! First, stocks and risky bonds tanked amid pessimism that a fiscal cliff deal could be reached. Then, thanks to some last-minute arm-twisting and negotiating, we got a deal after all. That caused stocks and risky bonds to soar.

But what about investors who have a time horizon of more than a few days? What should they take away from the holiday deal-making in Washington? That’s simple …

The fiscal cliff “deal” doesn’t really DEAL with our debt and deficit issues at all!

So after a bout of short-term relief, it’s hard to see how we make much progress! Let me explain why …

Deal punts on entitlements and punts on spending,
driving the budget deficit UP by almost $4 trillion!

By now, you probably know some of the details of the fiscal cliff deal. But just in case, here are the major points:

* Tax rates won’t go up on households earnings of less than $450,000 ($400,000 for single filers). But the top tax rate will climb to 39.6 percent from 35 percent for married couples earning more than $450,000.

* Taxes on capital gains and dividends for that group will also rise to 20 percent, though those rates will stay at 15 percent for everyone else. Taxes will also rise by five percentage points for large estates, and married couples who earn $300,000 or more will face caps on itemized deductions and exemptions.

* Unemployment benefits will be extended for another year, and tax credits aimed at lower-income families and college students will remain in place.

The markets initially celebrated the “good” news that taxes didn’t go up on a broader base of filers, and by a bigger amount. They also liked the fact a deal was reached at all. But there’s a lot not to like here too!

Washington’s deal totally ignored out-of-control spending.

For starters, the payroll tax cut won’t be renewed. That means two percentage points more income will be taken out of everyone’s paychecks immediately, something that will weigh on consumer sentiment and spending in 2013.

What’s worse: The deal didn’t deal with out-of-control spending at all! Instead of allowing the deep cuts to domestic and military spending that were part of the “sequester,” it just punted on the issue, delaying those cuts for 60 days.

Bill boosters say that delay will give Congress time to come up with longer term, serious spending cuts. But politicians have been kicking the can down the road on this issue for more than two years! There’s no reason to expect an additional two months will result in politicians reaching a “grand bargain” on cuts.

Indeed, the deficit will actually rise by an additional $3.9 TRILLION over the next decade because of the legislation, according to the Congressional Budget Office! Spending would climb by $330 billion during that ten-year period.

Given the ongoing use of short-term, can-kicking maneuvers, plus the lack of meaningful deficit reduction, I don’t see how we avoid more ratings agency downgrades in the wake of this deal. That’s another negative.

Expect More Fights,
More Discord in 2013

As if that weren’t enough, the deal didn’t include any provisions related to the debt ceiling. We just hit the $16.4 trillion borrowing cap, forcing the Treasury Department to resort to extraordinary measures to keep the debt markets functioning.

But that financial finagling can only push the deadline out by about two months. That means Congress and the President will soon be fighting yet again about the budget, leading to more uncertainty and volatility.

So sure, I can find select companies and assets that are worth investing in here. But I don’t believe that the reaching of a deal is a huge game changer. Instead, we’re now facing an extended period of budget battles … higher taxes … and a potential market-shaking streak of sovereign debt downgrades. That’s why I remain cautious in my investing strategy as 2013 gets underway.

Until next time,

Mike