How important is the fiscal cliff for investors? Hint: Not very
Barry Ritholtz
Washington Post,  December 1 2012



The “fiscal cliff” paranoia continues unabated. 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!

Whenever the media obsess over a potential crisis, history teaches us that it is most likely to be overwrought hype. Recall the Y2k frenzy as Exhibit 1 in The People v. Really Bad Media prosecution.

Want to learn just how absurdly obsessive the media have become over this? Just type “fiscal cliff” into Google Trends and you will see how, post-election, the term’s appearance in the media simply went ballistic.

Where did this sudden spike in mentions begin? The Columbia Journalism Review points to coverage such as that of the financial network CNBC. Ryan Chittum, who reports on the business media for CJR, notes that CNBC began a campaign called Rise Above that blanketed its airwaves since the day after the election with pleas for a solution to the fiscal cliff. As Google’s trend chart shows, it was part of a media dogpile — at least until the David Petraeus affair sent the drones scurrying after a more salacious story.

What does the fiscal cliff mean to investors?

Let’s start with a definition: The term refers to the deal that Congress made in late 2011 to temporarily resolve the debt ceiling debate. The “sequestration,” as it is known, calls for three elements: tax increases, spending cuts and an increase to the payroll tax (FICA). The Washington Post’s Wonkblog has run the numbers and finds “$180 billion from income tax hikes, $120 billion in revenue from the payroll tax, $110 billion from the sequester’s automatic spending cuts and $160 billion from expiring tax breaks and other programs.”

That is a not-insignificant amount of money, but it is hardly the end of the world. To put this into context, it is a little less than the TARP bailout for Wall Street in 2009 and somewhat less than the American Recovery and Reinvestment Act, President Obama’s stimulus package. An educated guess puts this at about $600 billion to $700 billion out of a $15 trillion U.S. economy. I’d ballpark that at about 4 percent of the GDP, or 0.50 percent of the forecasted GDP growth of 2 percent for calendar year 2013.

The term “fiscal cliff,” popularized by Fed Chairman Ben Bernanke, is really a misnomer. As several analysts have correctly observed, the effects of sequestration are not a Jan. 1, 2013, event. The impact of the spending cuts and tax hikes would be phased in over time. A fiscal slope is more accurate. Additionally, as students of history have learned, single-variable analysis for complex financial issues is invariably wrong. Because of the inherent complexity of economies and markets, we cannot adequately explain or predict their behavior by merely looking at just one variable.

Given all this, what else might be driving equity markets? Consider the following factors as the causes of recent volatility:

Weak corporate profits: If you want to understand market jitters, look no further than falling earnings growth. Profits and revenue have disappointed in the third quarter, coming in below estimates. As the Wall Street Journal noted, this has been the “worst quarter for corporate profits in three years.” Even worse, future estimates for earnings growth keep sliding. In July, estimates for fourth-quarter profit were annualized gains of 14 percent. By October, that fell to 9.6 percent. It has now slipped to 5.5 percent, according to S&P Capital IQ.

Markets got ahead of themselves: For the first three quarters of the year, the markets put up impressive numbers, with the S&P 500-stock index gaining 17 percent, and the tech-heavy Nasdaq running up over 23 percent. Those are great numbers versus historic average gains of 10 to 11 percent. Given the mediocre post-credit crisis recovery and the softening earnings growth, perhaps markets simply got too far ahead of themselves.

Wall Street bet wrong on the elections: Lots of people seem to be saying that recent market turmoil is based on the financial community’s evaluation of a possible deal between the White House and Congress.

Do not pay much attention to Wall Street’s assessment of politics. Let me remind you that the Street made very heavy bets on Mitt Romney winning the election. This was both in the campaign donations made by Wall Street firms as well as how fund managers and traders positioned their portfolios. They all misread what turned out to be an Obama electoral college blowout of 332 to 206.

The sell-off since the election is as much about how a mispositioned Street was reversing itself as anything else.

Those are probably the three largest factors. Of course, the euro-zone sovereign debt crisis is unresolved, and most of Europe is in a recession. In Asia, growth has been slowing, especially in China and India. And then there is the decreasing impact of Federal Reserve interventions in the markets. We seem to be getting less bang for the buck with each subsequent QE.

I submit that all of these other factors are weighing much more on equity markets than the fiscal cliff.

I am much more concerned about declining earnings and what they mean for the possibility of a recession in 2014. You should be, too.


Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter: @Ritholtz.

Category: Apprenticed Investor, Politics

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

14 Responses to “How important is the fiscal cliff for investors? Hint: Not very”

  1. 4whatitsworth says:

    If the market were completely rational this could be true. However the perception is that if we go over the cliff we go into recession and in recessions the market corrects 20%. It is possible that this will be an old fashion self fulfilling prophecy.

    You have to admit we are in a very uncertain situation and that is definitely not good for the markets. Look for the democrats to blame the republicans and slow international growth for the next recession if that happens. Anyone remember when we were economic leaders? “When the US sneezes the rest of the world catches cold” remember that saying?

    The good news if you are holding stocks is that the new financial regulations have cleaned up the balance sheets so the quality of the earnings and capital accounts are the best they have been in a long time. This could be our saving grace.

  2. Chrisbo says:

    Solid post. However, did you mean to write 2013 in the last paragraph?

  3. James Cameron says:

    > 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!

    Actually, I think the markets for the time being have concluded that something is going to get worked out, whence the relative lack of volatility despite the daily headlines. I think if something doesn’t get worked out and the issue drags out into next year it will be a much different story. We shall see . . .

  4. carleric says:

    Anything that Bernanke can define can’t be all that relelvant or important….it is mostly frustrated Keynesian bemoaning any reduction in government spending. I think Shakespeare defined it best when he said “it is much to do about nothing”

  5. tdotz says:

    Wild Bill Clinton nailed it: “Kabuki theatre”

  6. John Clarke says:

    Given all this, what else might be driving equity markets?…. “…And then there is the decreasing impact of Federal Reserve interventions in the markets. We seem to be getting less bang for the buck with each subsequent QE….”
    Well that’s true but it is the Continued Belief by the Markets that any Substantial sell-off, and Stalemate over the Fiscal ‘Slope’, is going to be met with even more Quantitative Easing– QEternity (currently 85 Bil./ month) by B.S. Bernanke and his fellow Wall Street Whores at the Federal Reserve (and make No Mistake– They Are Targeting the Stock Market). Next week we’ll see what Christmas Gift Little Ben and his Merrymen bestow upon the Markets…
    Looking at the European (the DAX in particular..), Chinese and Japanese Markets you would think their problems are, for the most part, resolved.

  7. 873450 says:

    Deadline Looms for Long-Term Unemployed
    Benefits for More Than 2 Million Could Expire at Year-End

    For these 2 million Americans held hostage the cliff is very real.

  8. Incredulous says:

    Federal Gov Total Revenue 2011: $2.3 trillion. Increase in taxes quoted in this article: $300 billion. That’s a change of about 13%.

    We could manage that every year. No problem! It’s just a slope. Like the slope Sisyphus pushes his stone up, in Tartarus, for all eternity.

  9. GGJr says:

    Barry says: “I am much more concerned about declining earnings and what they mean for the possibility of a recession in 2014. You should be, too.”

    And having King Barry 1 sucking 300 billion more out of the private side of the economy than he already does is going it increase earnings (aka profits) in what way exactly? Last I read tax revenues to the Black Hole in DC were the 4th largest in history

    it seems to me we have a spending problem, not a taxing problem.

    Just sayin’

  10. Pantmaker says:


    I agree this all of this “fiscal cliff crisis” is a side show…and you are dead nuts right about earnings concerns… but what’s up with this 2014 recession possibility? Did you mean, in addition to the one that we are currently in that most likely started in the third quarter? This market is clueless about our economic situation and my guess is the reality won’t set in until people are picking their nuts off of the floor with a bottom tick of S&P 475. I am not a doomer or a prepper or tea bagger…I just don’t see any way to keep this David Copperfield levitation trick going much longer.

  11. SecondLook says:

    Re: Market historical returns.

    …versus historic average gains of 10 to 11 percent

    I hate to quibble about one detail, but that incorrect figure keeps coming as an automatic baseline assumption all the time by investors, and it’s incorrect.

    Total market return, dividends reinvested – excluding any friction (transaction expenses, taxes, inflation):

    October 1952 to October 2012 (60 years): 7.029%
    October 1972 to October 2012 (40 years): 7.128%
    October 1992 to October 2012 (20 years): 6.408%
    October 2002 to October 2012 (10 years): 5.272%

    Note that the above uses a slightly more generous start, i.e. beginning in a month that usually commences a market rally. Using say, January 1952 to January 2012 reduces the 60 year return to 6.867%.

    During the entire history of the market from 1871, as constructed by Robert Shiller: 4.180%

    It’s the great bull market of 1982-1999 that tends to skew the mistaken notion for investors, that was the extraordinary period when the return was 14.972%.

    Now, if you do discount returns by the rate of inflation, what is the purchasing power of your investment currently as opposed to what you initially invested, then the numbers become even more modest. Over the past 60 years, the adjusted return on investment averages 3.234%.
    I know, no one bothers to consider what their return is worth that way, we really don’t like to think about inflation, save when it’s “unusually” high; but any rate of inflation eats away at profits.

    I think we would all be better served if people wrote: “Long term market returns are likely to be around 6-7%, before costs and inflation. When the market returns much better than that, be happy, but be wary. Don’t count on it lasting over your investing lifetime.”

  12. SecondLook says:


    Look at the inflation adjusted numbers rather than the nominal. Just as real GDP is used instead of nominal when discussing economic growth rates, so real revenue growth/decline is more indicative than nominal. The same way you would calculate changes in your personal income – you’re not really earning more if your raises just covers the increase in your costs.

    For those of you curious about real Federal revenues here is the following table:

    1998: 2,040.9
    1999: 2,136.4
    2000: 2,310.0
    2001: 2,215.3
    2002: 2,028.6
    2003: 1,901.1
    2004: 1,949.5
    2005: 2,153.6
    2006: 2,324.1
    2007: 2,414.0
    2008: 2,288.1
    2009: 1,899.0
    2010: 1,927.9
    2011: 1,998.7
    2012: 2,089.4

    Essentially, what the government is taking in is about the same, in purchasing power, what it did back in the Clinton years.

    I really don’t understand why people want to ignore the increase in cost of goods and services over time, and the impact it has has on everything from investing, to living standards, to corporate earning, government expenditures, etc.
    I’m not paranoid about inflation, but accept it as an effect on our lives and our choices.

  13. icm63 says:


    Importance of a NEWs item does not matter. What matters is HOW the market will use the news to scare the weak hands to unload precious stock float. Wyckoff law 101 !