America is looking over the precipice of the fiscal cliff and it
appears that a dealwill not be reached before the New Year. About
$600 billion in spending cuts and newtaxes will begin to drag
theeconomy lower, but despite what you might hear in the financial
news, the fiscal cliff could be a golden opportunity.
The markets have sold off more than 4% since their September
high and could give back another 10% if no deal is reached early in
the New Year. While many anxiously await every headline from
Washington and others have fled stocks all together, informed
investors are crafting a plan to take advantage ofmarket
A fiscal molehill
The media has dramatically over-hyped the so-called fiscal cliff.
The majority of the drag will be from increased taxes which will
take affect slowly through payroll and income taxes. This means the
actual drag on the economy will be a gradual reduction rather than
anything as dramatic as a cliff. In fact, the relative size of the
fiscal drag has happened three other times in the last 60 years:
1951, 1960 and 1969. In all three years, the fiscal drag was
accompanied by monetary restrictions by the Federal Reserve, and
arecession only resulted in 1960 and 1969, with both being fairly
Ben Bernanke and the rest atthe Fed are nowhere near the point
where they will start pulling back on monetary stimulus. In fact,
they have explicitly guaranteed that policy will stay accommodative
until unemployment comes down to 6.5% orinflation increases above
2.5% a year. The real effect of the fiscal cliff is the negative
sentiment it has caused rather than any economic certainties.
The stars align
After the fiscal cliff, the market is facing a surprisingly great
environment in 2013. Europe has started to rebound, with itscentral
bank ready to lend "as much as it takes" to debtor members. While
we could see short periods of volatility in 2013, the commitment by
the ECB and a softening to stimulus by Germany has taken a breakup
off the table. Growth may not come roaring back next year, but a
gradual workout will improve investor sentiment.
The Bank of Japan has already consented to implicit threats by
its newPrime Minister and has doubled its inflation target in a
sign that large-scale monetary stimulus is on the way.
Manufacturing in China, meanwhile, grew at the fastest pace in 19
months in December. So the world's second largest economy appears
ready for round two of its economic growth story. Together, the two
Asian economies account for almost a fifth of globalGDP and should
support both growth and sentiment.
The United States is just coming into a secular rebirth of
American energy and manufacturing growth that the markets have yet
to fully appreciate. [Street Authority's Nathan Slaughter has
touched on some of the biggest opportunities in this area
Combine this renaissance in industrial growth with the fact that
corporations are sitting on a historic
incash and you get the ingredients for significant growth down the
line. In fact, global mergers & acquisitions surged in the
fourth quarter to the highest level in four years -- a sign that
companies are finding value and looking to the future.
A New Year's strategy
The S&P 500 is currently trading at 16 times trailingearnings ,
with next year's profits expected to increase by about 17% (for
aP/E of 13.7). While factors point to strong growth in 2013,
thisprice multiple is slightly above the long-term average P/E of
about 15, and I don't know about you, but this value investor is
not excited about jumping into new stock positions.
A fiscal cliff-induced 5-10% drop in the market, however, would
bring valuations down significantly and set investors up for great
returns next year. For example, if we assume a trailing price
multiple of 15 at the end of next year, to the S&P would be at
1537, which is only 9.8% higher than current levels. But if
we can buy into a position closer to 1300, then the rebound
would produce a 17.9% return.
Why am I not worried that going off the cliff could result in
losses beyond the first month of the New Year? Going over the cliff
is going to incite so much vitriol for those in Washington that a
deal will be reached by the end of January with largely retroactive
stipulations. Basically, the government is giving savvy investors a
chance to buy into next year's growth at discounted
Risks to Consider:
A fiscal cliff deal will eventually get passed, though it is
less certain when Congress and the President will come to an
agreement. I would recommend a laddered approach to getting back
into the market rather than waiting for a singular low entry point
that may never come.
Action to Take -->
Investors should take advantage of a further selloff in the market
toprofit from some really promising growth next year. It is rare
that the market offers a chance to get in at a lower price point
ahead of strong tailwinds for growth, but the fear surrounding the
fiscal cliff isoffering a gift that many investors do not fully
I am positioning my own portfolio inbonds and defensive stocks
Philip Morris International (
, which pays a 4.1%dividend yield , and should be fairly insulated
against a market selloff. [Phillip Morris is a great example of
what wecall a "
," which is why it's a cornerstone in StreetAuthority Co-Founder
portfolio as well.]