by Ed Elfenbein | December 1, 2012 8:00 am
Wall Street’s fortunes seem to be beholden to the Fiscal Cliff (a registered trademark of CNBC). Late in the day on Tuesday, some rather casual remarks by Senator Harry Reid were enough to knock a few points off the S&P 500. The same thing happened again on Thursday, but this time, the remarks came from House Speaker John Boehner. Then, as word of progress leaked out, well…the market started to gain traction.
Let me be clear: The threat from the Fiscal Cliff is greatly, hugely and fantastically exaggerated. It’s almost reached comical levels. The behavior at CNBC in particular has been reprehensible. The network is simultaneously over-hyping the threat while presenting themselves as the saviors. Folks, there’s nothing to worry about.
Of course, if we really were to go over the cliff, that would be bad news—and that’s precisely why it won’t happen. In the meantime, both sides need to prove to their respective bases that they’re not backing down. It’s for show, like you see in a nature program about silver-backed gorillas fighting for dominance.
But let’s get some facts. For one, the threat is easily avoidable. The White House and Congress have too much to lose by not reaching a deal. In fact, a recent article at Politico suggests that, despite the rhetoric we hear in public, the framework of a deal is starting to take shape. Neither side will get everything it wants, but they’ll both get enough to walk away with some pride.
Also, remember that this deal is being made with the lame-duck Congress. That means there are a few folks who won’t even be members of Congress in a few weeks. In fact, a deal may even be reached some time in the new year. In a few months, no one will be talking about this.
The market has resigned itself to the fact that taxes will go up. That’s no surprise. In response, dozens of companies like Costco (NASDAQ:COST) and Las Vegas Sands (NYSE:LVS) have announced special dividends.
Other companies like Walmart (NYSE:WMT) have moved up their dividend dates in order to avoid the taxman. An analyst at Deutsche Bank (NYSE:DB) suggested that Bed, Bath & Beyond (NASDAQ:BBBY), one of our Buy List stocks, could pay a special dividend. I’m a doubter, but I will note that the home-furnishings company is sitting on $4 per share in cash.
One good way of putting the Fiscal Cliff threat into perspective is by looking at how well defense and aerospace stocks are doing. Needless to say, any sequester would be very bad news for these companies.
The Defense Sector ETF (NYSE:ITA) badly lagged the market for most of this year. Its relative performance reached a low point in late September, but then, except for a brief period in mid-November, the ITA has been leading the market ever since. This tells me that that no one has the motive for a prolonged fight.
Furthermore, the Volatility Index (NYSE:VIX) has remained subdued, and the stock market has largely avoided wild daily swings in the past few weeks. There’s only been one daily swing of more than 2% in the last two months, and that was the big sell-off on the day after the election. This has been a calm market.
Due to market leadership from the Industrials and Consumer Discretionary sectors, I suspected that the sell-off would be short-lived. That’s not the script that sell-offs usually follow. Since June 5th, the Consumer Discretionary ETF (NYSE:XLY) is up by 12.2%. In simpler terms, the home builders and shoppers are waking up from their slumber. Even some crummy tech names have been doing well. Thanks to a jump in shares of Facebook (NASDAQ:FB), Mark Zuckerberg has made a cool $4 billion in the last three weeks.
The good news about pending home sales, combined with a positive report on home prices, suggests that the housing recovery (such as it is) is propping up consumers. Mind you, there are still weak spots out there. Tiffany (NYSE:TIF), for example, just lowered guidance. But these are special cases rather than general rules.
Probably the best news for investors this week was largely ignored. Charles Evans of the Federal Reserve said that the Fed needs to extend its bond-buying programs until the economy can consistently add 200,000 jobs per month. Until now, the Fed has been reticent in giving a specific economic target as to when they need to take their foot off the gas. I don’t know if Evans will get his way, but we now know there are some voices inside the Fed willing to pursue these policies.
The bottom line is that there’s no possible solution to the Fiscal Cliff that alters the value spread between stocks and bonds. With the Fed gobbling Treasuries like Santa eating cookies, yields are low and will likely remain so. In fact, the austerity that would result from a Fiscal Cliff deal would add even more pressure.
Let’s look at some numbers. Analysts now expect 2012 earnings for the S&P 500 of $99.76, and $113.40 for 2013. In June 2011, analysts expected the S&P 500 to earn $111.82 for 2012. So that’s a big change in outlook, yet the market rallied.
The reason we rallied is that the market had dramatically overreacted to fears from Europe. Over the last 14 months, earnings estimates for Q4 have come down, on average, about 1% per month. Yet even these lowered numbers represent an acceleration of earnings growth. Prudent investors are in excellent shape right now. The indexes are up, and dividends are having a banner year.
I think the S&P 500 can hit 1,500 by March.
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