House Speaker John Boehner made a huge political miscalculation that put the fiscal cliff negotiations basically at a standstill. And at this point, the prospects for a grand bargain are very low. The most likely scenario is some sort of a smaller deal to reduce the effect of the cliff (the tax hikes). Then negotiations for a bigger deal centered around significant entitlement and tax reform can resume later in 2013.
The two most likely outcomes of the fiscal cliff negotiations are:
1) A deal that extends the Bush tax rates for everyone under the $200,000/$250,000 threshold but doesn’t have any spending reductions, doesn’t extend the debt ceiling, or address the mandatory spending cuts (known as the sequester). Or …
2) A bigger deal that is close to what the principals were working toward before the Plan B vote debacle. It might be something like tax rates staying the same for everyone making under $500,000; one-for-one spending cuts, a chained CPI shift for increases in entitlement benefits, and a one-year extension on the debt ceiling and removal of the sequester.
From a market standpoint, however, even if a deal is struck, the only positive outcome will be one where they settle the debt ceiling increase issue and ensure we won’t all have to get dragged through these negotiations in another two months.
Implements Stall Tactics
In fact, last week the Treasury Department formally announced it has run out of borrowing capacity, and it’s employing emergency measures that give it two more months of room. This announcement wasn’t a surprise, but it highlights the importance of the debt ceiling. Ratings agencies could downgrade the outlook for U.S. debt to negative on the news.
|Timothy Geithner said the Treasury must undertake “extraordinary measures” in order to buy more time before defaulting on loans.|
The key here is uncertainty. Unless there is a deal to extend the debt ceiling and some credible progress towards longer term fiscal reforms in this country, we can expect Washington to be a drag on stock prices in the 1st quarter of 2013 — even if a fiscal cliff deal is done. The reason is simple: The political circus will be back in town in February as they argue over the debt ceiling.
As an investor, you always want to be allocating capital towards areas of clarity. Yet the net result of these fiscal cliff and debt ceiling debacles is less clarity in the U.S. On the other hand, the rest of the world is moving towards more clarity, especially China where growth is reaccelerating; Japan, which has political certainty; and even Europe, which continues to recover from the sovereign debt crisis.
So as Washington dithers, I suggest you look abroad for clarity and outsized returns.
One way to play this is through the iShares MSCI EAFE Index Fund (EFA). This exchange traded fund gives you long exposure to Europe, Australia and the Far East … areas of growing clarity compared to a U.S. mired in governmental incompetence.