Who's Afraid of a Fiscal Cliff

We cast our gaze toward Thanksgiving Day tomorrow, thankful to see a majority of Americans — OK, a majority of people responding to a thoroughly unscientific Yahoo Finance poll — tuning out the “fiscal cliff”…

Golly, you could hardly tell if you immerse yourself in the financial media. “The nonstop fiscal cliff paranoia continues unabated,” writes money manager and Vancouver fave Barry Ritholtz. “Apparently, it is the ONLY THING that matters to the markets. Every twist and turn in the negotiations is crucial to the future of the Republic.”

“It behooves investors to consider what else is driving equity markets,” Mr. Ritholtz gently suggests. “I can think of at least five factors:

1) Earnings are the weakest in 3 years

2) Portfolios have been poorly positioned for higher capital gains and dividend taxes

3) Europe crisis unresolved, and getting worse

4) The 17% rally in first 3 quarters had markets ahead of themselves

5) The decreasing impact of Federal Reserve QE.

“The fiscal cliff amounts to about $600 billion in friction spread out over the course of 12 months,” he says. “Fair estimates are that it will cost about 0.50% off of GDP, now estimated to be about 2.0% for the calendar year 2013.

“I submit that these other factors weigh at least as much, if not more, in the market’s current action.”

The major U.S. stock indexes are inching up this morning. The Dow has pushed above 12,800.

For the few traders on duty today, factor 3) above is in view: Eurozone ministers failed to come to terms overnight on Greece’s next bailout payment. “We discussed the issue very intensively, but since the questions are so complicated we didn’t come to a final agreement,” says German finance minister Wolfgang Schauble.

Another meeting is scheduled Monday: EverBank’s currency guru Chuck Butler isn’t holding his breath. “After a period of somewhat calm, the risk fears are returning to the eurozone. And that will weigh heavily on the euro, just like it did earlier this year.” The euro has retreated to $1.28. The dollar index sits at 80.9.

Elsewhere first-time unemployment claims dropped (dramatically) to 410,000 from an upward-revised (dramatically) 451,000. Bloomberg, citing a Market News International report, says the Labor Department “has no handle on the magnitude or duration” of the effects from Hurricane Sandy. Sounds about right.

Crude has firmed a bit to $87.51. Precious metals are in retreat, gold at $1,724, silver at $33 on the nose.

“Probably nothing good will happen in the discussions surrounding the ‘fiscal cliff’ in January 2013,” writes Nathan Lewis.

Mr. Lewis, who oversees a private investment partnership and wrote Gold: The Once and Future Money (with a foreword by Addison), offers one of the few worthwhile fiscal cliff insights in a recent post at Forbes.

“Federal spending is almost impossible to cut meaningfully,” he writes, “because most of it is ‘mandatory’ entitlements. The remainder of federal government spending consists of other welfare programs (hard to reduce in the midst of persistent unemployment), defense (which Republicans won’t want to cut unless they get some big cuts in welfare and entitlements), corporate subsidy and Big Bird.

“The result is likely near-stasis on spending, and, despite Republicans’ efforts to the contrary, some tax rate increases. This is the ‘austerity’ approach that is not working at all in Europe…

“Deficits will likely continue and perhaps get even larger. The economy will deteriorate, while the rest of the world slips into its own recession.”

Enter the Federal Reserve, which in all likelihood will step up QEternity on Dec. 12, turning Operation Twist into full-on monetization of government debt. “Thus,” Lewis writes, “the Federal Reserve would be buying $85 billion per month of Treasuries and MBS, financed with the printing press. That is $1,020 billion per year, not coincidentally about the expected amount of the Federal budget deficit…

“Probably, this will end badly. Next year might be quite exciting.”