Five with Fitz: What to Expect If We Go Over the Cliff

by Keith Fitz-Gerald | November 16, 2012 10:02 am

Five with Fitz: What to Expect If We Go Over the Cliff

I’m on the road quite a bit and enjoy receiving lots of great questions as from fellow Money Morning subscribers. Here’s a few that really caught my attention. Not surprisingly, one of the biggies deals with the fiscal cliff.

Q – What happens if we go over the “fiscal cliff”…really? – Jerry S.

A – Nobody truly knows Jerry. However, here are five things I expect to happen as a result.

First, the U.S. goes back into recession. The CBO (Congressional Budget Office) suggests there will be a 0.5% contraction if the government can’t stop both the debt and the spending cuts. That’s a huge drop from the 2% growth it presently expects.

I think both numbers are complete fantasy, incidentally. The government missed this crisis in formation and they are flying blind now. How on earth they can predict 2% growth right now defies any sort of logic whatsoever. Then again, we are talking about the federal government. Sigh.

If we go over the fiscal cliff, I’m expecting as much as a full 1% contraction. And growth under the circumstances will hardly be normal, let alone 2% for years to come. The fiscal cliff and our politicians’ unwillingness to do anything about it other than kick the can down the road so far makes it clear to me that America is going to struggle with the legacy of decades of bad fiscal policy for years to come — just like Japan has for more than two decades.

Second, I think companies are simply going to vote with their wallets under the circumstances. Many are already hoarding dollars and announcing changes to operations following the election, but now they’re going to cut back further on capital spending.

At the same time, the fiscal cliff will reduce foreign direct investment into the U.S. because many companies will shift their attention to other markets where there is more certainty.

Third, the unemployment rate will rise, housing markets will reverse course, and the Fed will engage in yet more meddling and more money printing. It will no doubt be well intentioned, but simply digs America further into a hole.

Fourth, the government will continue to raise taxes on the “rich,” only they will broaden the bag so as to sweep in much of Middle America. People who are content to think this strategy applies only to the “super rich” haven’t yet keyed in on how broad this net will actually be. I think they’re in for a rude awakening.

As part of this process, I expect Congress to make a grab for retirement assets, and attempt to force those who want to save for their future to save for Washington’s future as a part of some sort of mandated savings requirement. Chances are they will engage in some tax reform when it comes to municipal bonds and other income- oriented investments, too.

Fifth, the markets will falter and perhaps even correct by 20%, as Marc Faber recently suggested on CNBC. No doubt that’s going to stink on a variety of fronts. But a retracement will also put a slew of great companies on sale and create unbelievable opportunities in everything from gold, inverse funds, certain bonds, and especially the “glocal” stocks we prefer.

I don’t share Washington’s optimism that things will magically get fixed, which is why we’ve been preparing Money Morning readers and those of our sister service, The Money Map Report, ahead of time for this contingency. As part of that, we’ve been selling into strength, picking up metals and tightening up our trailing stops.

Having bought into the markets off the 2009 lows, I am not anxious to see subscribers lose the gains many are sitting on if they have followed along with our recommendations.

Now’s not the time to take anything for granted, especially when it comes to your money.

Q – I’m worried that the short sellers who were so problematic a few years ago will reappear and tank the markets. But I don’t hear a lot about it right now…why? – John S.

(Editor’s Note: John’s referring to the naked short sellers who made headlines early on in the financial crisis because of the amount of money they made betting that the prices of stocks (and other investments) would go down.)

A – Super question. There are a few factors at work. First, coming off the March 2009 lows, it’s been very hard for short sellers to establish positions because hard rallies don’t tend to create a lot of opportunities.

Second, much of the short selling was conducted by institutional traders working for big banks, in particular. They’re under the microscope right now so it’s not likely they are going to override their short rules again without incurring the wrath of an understandably angry public and deeply embarrassed regulators.

Third, the SEC has tightened up the borrowing requirements for short sellers so it’s no longer possible for more than one party to borrow the same shares of stock needed to effect the short. This reduces the number of shares available to short – in other words, there simply isn’t as much fuel available for the bonfire …

Q – How do you tell when institutions are getting cold feet and hedging? – Rhonda P.

A – Thanks for asking, Rhonda. Admittedly, this is more of an art than a science but here’s what I look for.

First, volume will generally begin to fall off. When coupled with prices that are still rising, it suggests the big money is distributing their shares to late comers. Typically you will see a rash of headlines “blossom” around the same time, or analyst reports touting yet more gains to ramp it up as a means of inviting the last people to the party before the lights are turned out. That’s why I frequently advocate selling into strength…because I’d rather be with “em than be left holding the bag they want to hand to unsuspecting buyers.

Second, looking at time and sales information, particularly for options on the big indexes, is a favorite of mine. When I see a “bloom” of activity that’s headed in the wrong direction from the major averages, for example, I know that something’s up…or about to be down.

Third, I look to the Commitment of Traders Report, or COT for short. Put out as a weekly report every Tuesday by the CFTC, it shows net long and net short positions for commercial and non-commercial traders. What makes this report interesting is that it frequently shows when traders shift from one side of the fence to the other, many times in advance of bigger market shifts.

Q – Loved your recent comments in the Wall Street Journal article on collectibles[1]; I’m also an avid motorcyclist. I’m wondering if now’s the time to diversify into other collectibles too? – Randy Z.

A – Thanks, Randy. One of these days we’re going to have to put together a Money Morning ride. I hope you’ll join in when we do.

As for collectibles, there’s no doubt they can provide significant portfolio diversification. However, there’s an important caveat – when you want to sell, collectibles are only worth what a buyer offers.

Sometimes that’s a lot, but sometimes that’s not. Collectibles pricing is closely related to overall economic conditions and the specificity of the collectible. The market for Picasso is very different, for example, than the market for early Chinese bronzes.

In closing, please keep those great questions coming. I enjoy receiving them and love answering them even more. You can send them to: keith@moneymorning.com[2]

Endnotes:
  1. article on collectibles: http://online.wsj.com/article/SB10000872396390443684104578064800307480808.html
  2. keith@moneymorning.com: mailto:keith@moneymorning.com

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