Cliff Diving, or Not

Given the prophecies from many economists that a failure to act on the fiscal cliff by Congress will bring economic doom, and given how sensitive the market has been to headlines over the past three years, the stock market’s recent even keel has surprised many observers, including us. Regardless of the market’s seeming indifference to the cliff, we still believe that a failure by Congress to agree on a solution prior to year-end would result in a sizeable drop in stock market prices. How sizeable?

In light of these recent precedents, we believe a failure by the politicians to reach any agreement prior to December 31 could push the Dow down by about 10%. There are arguments on both sides of the question as to whether or not some risk of going over the cliff is already priced into the market, but, let’s assume it hasn’t. We’ll explain later why we believe the risk of a big market selloff is less today than in the earlier stalemates. A 10% selloff would be a problem, but not a catastrophe, since bear markets, by definition, don’t start until the market drops 20% or more. However, the cliché about going over a cliff definitely applies here: It isn’t the fall that’s dangerous, it’s the landing.

Source: Donaldson Capital Management

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