By Ryan Vlastelica, Edward Krudy and Doris Frankel
(Reuters) - Investors fearing a stock market plunge - if the United States tumbles off the "fiscal cliff" next week - may want to relax.
But they should be scared if a few weeks later, Washington fails to reach a deal to increase the nation's debt ceiling because that raises the threat of a default, another credit downgrade and a panic in the financial markets.
Market strategists say that while falling off the cliff for any lengthy period - which would lead to automatic tax hikes and stiff cuts in government spending - would badly hurt both consumer and business confidence, it would take some time for the U.S. economy to slide into recession. In the meantime, there would be plenty of chances for lawmakers to make amends by reversing some of the effects.
That has been reflected in a U.S. stock market that has still not shown signs of melting down. Instead, it has drifted lower and become more volatile.
In some ways, that has let Washington off the hook. In the past, a plunge in stock prices forced the hand of Congress, such as in the middle of the financial crisis in 2008.
"If this thing continues for a bit longer and the result is you get a U.S. debt downgrade ... the risk is not that you lose two-and-a-half percent, the risk is that you lose ten and a half," said Jonathan Golub, chief U.S. equity strategist at UBS Equity Research, in New York.
U.S. Treasury Secretary Tim Geithner said this week that the United States will technically reach its debt limit at the end of the year.
INVESTORS WARY OF JANUARY
The White House has said it will not negotiate the debt ceiling as in 2011, when the fight over what was once a procedural matter preceded the first-ever downgrade of the U.S. credit rating. But it may be forced into such a battle again. A repeat of that war is most worrisome for markets.
Markets posted several days of sharp losses in the period surrounding the debt ceiling fight in 2011. Even after a bill to increase the ceiling passed, stocks plunged in what was seen as a vote of "no confidence" in Washington's ability to function, considering how close lawmakers came to a default.
Credit ratings agency Standard & Poor's lowered the U.S. sovereign rating to double-A-plus, citing Washington's legislative problems as one reason for the downgrade from triple-A status. The benchmark S&P 500 dropped 16 percent in a four-week period ending August 21, 2011.
"I think there will be a tremendous fight between Democrats and Republicans about the debt ceiling," said Jon Najarian, a co-founder of online brokerage TradeMonster.com, in Chicago.
"I think that is the biggest risk to the downside in January for the market and the U.S. economy."
There are some signs in the options market that investors are starting to eye the January period with more wariness. The CBOE Volatility Index, or the VIX, the market's preferred indicator of anxiety, has remained at relatively low levels throughout this process, though on Thursday it edged above 20 for the first time since July.
More notable is the action in VIX futures markets, which shows a sharper increase in expected volatility in January than in later-dated contracts. January VIX futures are up nearly 23 percent in the last seven trading days, compared with a 13 percent increase in March futures and an 8 percent increase in May futures. That's a sign of increasing near-term worry among market participants.
The CBOE Volatility Index closed on Friday at 22.72, gaining nearly 17 percent to end at its highest level since June as details emerged of a meeting on Friday afternoon of President Barack Obama with Senate and House leaders from both parties where the president offered proposals similar to those already rejected by Republicans. Stocks slid in late trading and equity futures continued that slide after cash markets closed.
"I was stunned Obama didn't have another plan, and that's absolutely why we sold off," said Mike Shea, a managing partner and trader at Direct Access Partners LLC, in New York.
Obama offered hope for a last-minute agreement to avoid the fiscal cliff after a meeting with congressional leaders, although he scolded Congress for leaving the problem unresolved until the 11th hour.
"The hour for immediate action is here," he told reporters at a White House briefing. "I'm modestly optimistic that an agreement can be achieved."
The U.S. House of Representatives is set to convene on Sunday and continue working through the New Year's Day holiday. Obama has proposed maintaining current tax rates for all but the highest earners.
Consumers don't appear at all traumatized by the fiscal cliff talks, as yet. Helping to bolster consumer confidence has been a continued recovery in the housing market and growth in the labor market, albeit slow.
The latest take on employment will be out next Friday, when the U.S. Labor Department's non-farm payrolls report is expected to show jobs growth of 145,000 for December, in line with recent growth.
Consumers will see their paychecks affected if lawmakers cannot broker a deal and tax rates rise, but the effect on spending is likely to be gradual.
Options strategists have noted an increase in positions to guard against weakness in defense stocks such as General Dynamics because those stocks would be affected by spending cuts set for that sector. Notably, though, the PHLX Defense Index is less than 1 percent away from an all-time high reached on December 20.
This underscores the view taken by most investors and strategists: One way or another, Washington will come to an agreement to offset some effects of the cliff. The result will not be entirely satisfying, but it will be enough to satisfy investors.
"Expectations are pretty low at this point, and yet the equity market hasn't reacted," said Carmine Grigoli, chief U.S. investment strategist at Mizuho Securities USA, in New York. "You're not going to see the markets react to anything with more than a 5 (percent) to 7 percent correction."
Save for a brief 3.6 percent drop in equity futures late on Thursday evening last week after House Speaker John Boehner had to cancel a scheduled vote on a tax-hike bill due to lack of Republican support, markets have not shown the same kind of volatility as in 2008 or 2011.
A gradual decline remains possible, Golub said, if business and consumer confidence continues to take a hit on the back of fiscal cliff worries. The Conference Board's measure of consumer confidence fell sharply in December, a drop blamed in part on the fiscal issues.
"If Congress came out and said that everything is off the table, yeah, that would be a short-term shock to the market, but that's not likely," said Richard Weiss, a Mountain View, California-based senior money manager at American Century Investments.
"Things will be resolved, just maybe not on a good time table. All else being equal, we see any further decline as a buying opportunity."
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also just a reminder- if you haven't done so already don't forget to cast your votes in mark's weekly(12/31-1/4), monthly(january), and also the quarterly poll (q1 2013) which are all set to close in a couple of days... mark will be starting us on a brand spankin' new spreadsheet for the new year... great job for everyone's participation in 2012 and a big time kudos goes out to mark for for his hard work and efforts on hsm! gl to everyone in the new year!
I can't believe I read such a thing, but House democrats are having an ice-cream party right now... I'm on my iPhone so I can't post the link, but I'm actually surprised that these retards are this retarded.
It's something called "Day Trading by the Day" and basically it says that of the closing price on the last trading day of the week is GREATER than the opening price, then the Set-Up is for a buy on Monday or the first trading day of the week.
If the closing price on the last trading day of the week is LESS than the opening price, then the Set-Up is for the SELL on Monday or the first trading day of the week.
Trigger: For a Monday buy Set-Up, the trigger is a BUY STOP rise of a given number of points on Monday ABOVE the high of Friday. For a sell Trigger we use a SELL Stop price a given number of points BELOW the low of Friday. Buy stops and sell stops are used at these points to enter these positions. NOte that the number of points required to trigger varies from market to market but generally even a few ticks or cents will do.
The Follow-Through consists of a stop loss and exit at the end of the day.
I found this in the book, The Ultimate Day Trader so to apply this to today's close, we should expect a lower open on Monday. This has been statistically proven to work more often than chance would allow it, so I guess it's something to think about. The fiscal cliff debacle will probably make this negate this theory because no one knows if we'll get a deal or not. However, markets are positioned to make us believe a deal will not be struck.
You peaked my interest. I was unable to replicate your results.
BUY: Bar[Close,W] > Bar[Close,W,1]
SELL: Bar[Close,W,1] > Bar[Close,W]
I need info on the possible sell trigger to complete the backtest.
How in the world are futures up... Last week we jumped or fell 20 points on /ES just by hearing they'll meet or not meet and today we're up because they have absolutely no plan? Insanity and more proof that markets will probably go up even on a BS deal so that investors can think all is fine (not even the fiscal cliff brought us down) and the big funds can unload their longs unto them. Volume should be specially noted this upcoming week. I expect a massive correction and the beginning of a bear cycle sometime in mid to late January.
yea they cant keep it pumped up forever...up year for equities and yet another year in the tank for rest of the economy....guess they thought pumping the stock market would trickle into general public and industry...didnt happen