Fiscal Cliff: No Grand Bargain, But Enough for Now
January 7, 2013
by Joanna Shatney
of Schroders Investment Management
Although the best case scenario is off the table, US markets are breathing a sigh of relief that the tax cliff has been averted – at least for a few more months. The final package holds enough for both the bears – given that we will have to revisit the fiscal worries in the next few months – and for the bulls – who believe that the near-term risks have been pushed aside.
It has been our belief that the cliff would be manageable and that as long as the wall of worry continued to exist, US equity markets should continue to move higher in 2013, given low expectations and low historical valuations.
The current bill presents some pros and cons: the bill effectively extends the majority of the Bush tax cuts, while placing greater tax burdens on higher income earners including higher marginal income tax rates, and higher taxes on capital gains and dividends. However, we are slightly worried about the payroll tax holiday that was not extended; a potential hit to lower income earners. These increases in taxes, albeit smaller than the cliff event itself, should still crimp GDP growth in the first quarter.
The main overall concern is that the situation is still not resolved. In November and early December, there were some hopes that the year-end deal would incorporate some discussion on spending cuts and the budget deficit. However, both have essentially been pushed to the end of February/early March for discussion, which creates additional worry for global markets.
Estimates of the necessary spending reduction are largely unchanged: targeted at around $3.5-$4.5 trillion. Given how contentious the last several discussions have been and how they have gone ‘down to the wire’, we are assuming these discussions will not be easy either.
The views and opinions contained herein are those of the Joanna Shatney, Head of US Large Cap Equities, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
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