Investors have not priced in the possibility of the fiscal cliff hitting the U.S. economy, but many believe a last-minute deal in Congress can be worked out and Federal Reserve easing will calm the waters, fund manager BlackRock said in a new report.
“The S&P 500 Index is close to record highs and volatility is eerily low,” the report states. “Markets have not priced in the fiscal cliff and assume QE Infinity [the third round of quantitative easing] will drown out other factors.”
The fiscal cliff, a series of spending cuts and tax hikes that will go into effect in January if a bipartisan deal is not reached, could reduce gross domestic product by 5 percent and cost about 2 million jobs, according to the Congressional Budget Office.
Editor's Note: 'It’s Curtains for the US' — Hear Unapologetic Warning from Prophetic Economist.
The only chance of reaching an accord will come after the November presidential election, and that will barely give Congress time to work, BlackRock said.
BlackRock sees three possible scenarios regarding the fiscal cliff:
A “Sky Dive” off the cliff would occur if President Barack Obama wins a second term because Democrats and Republicans would be unlikely to reach an agreement during the lame-duck session. Markets would succumb to “high anxiety.”
A “Bungee Jump” would occur if Republican nominee Mitt Romney wins the White House and Republicans sweep Congress, although again an agreement would not likely be reached in the lame-duck session. The win would be met with a wave of initial “euphoria,” as tax hikes would be reversed retroactively and the debt ceiling would be raised as a first step toward a full budget deal, according to BlackRock.
Another possibility is a “Hard Stop” just before the cliff. In that event, lawmakers would agree to some spending cuts and then reach a budget deal next year, BlackRock said. Enough signs and specifics that a real budget deal is in the making would lead to market “bliss.”
But investors have to watch out for a sell-off in risk assets, such as U.S. equities, ahead of the fiscal cliff.
That might already be happening, according to CNNMoney.
The exodus from stocks picked up last week, as investors withdrew nearly $10.6 billion from U.S. stock mutual funds in the week ended Oct. 3, the most since August 2011 when the U.S. credit rating was downgraded by Standard and Poor's, according to data from the Investment Company Institute.
The total outflow this year from U.S. mutual funds comes to more than $100 billion, compared with around $57 billion during the first nine months of 2010, and $80 billion during the same period in 2011, CNNMoney reported.
Editor's Note: 'It’s Curtains for the US' — Hear Unapologetic Warning from Prophetic Economist.
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