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Stocks May Free Fall If Fiscal Cliff Deadline Is Missed

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Though analysts say the markets see January 1 as a "soft deadline."

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Despite the heightened volatility and sustained selling, stocks have not taken the type of panicked tumble they suffered during other recent displays of Washington dysfunction. In September 2008, during the depths of the financial crisis, the Dow lost more than 777 points – and stocks overall shed more than $1 trillion in value – after the House of Representatives voted down a bank bailout package. In August 2011, the S&P 500 lost 8.5 percent in three days as President Obama and lawmakers took negotiations on raising the debt ceiling down to the wire, prompting a downgrading of the country's sterling AAA credit rating by Standard & Poor's. From July 22 to August 19, the S&P 500 sank 16.5 percent.

"For now, as long as the two sides are talking and some sort of deal (any deal) is on the table, markets will keep their cool," wrote IHS economists Nigel Gault and Paul Edelstein on Friday. "The bad scenario is when there is no perceived progress and no communication between lawmakers." The markets likely view January 1 as a "soft deadline," they noted. While the more than $500 billion in tax increases and spending cuts go into effect with the new year, the economy wouldn't be plunged into recession overnight, as businesses and consumers would only feel the full brunt of the imposed austerity measures over time. That leaves time for politicians in Washington to undo at least some of the damage, but the IHS economists say that, "the two sides would have to be locked in negotiations for markets to remain patient."

But if the market has been patient thus far and the drops tame compared to those past plunges, analysts and investment strategists expect that anxieties will only grow the deeper we go into January without a deal. Compounding those cliff fears, the U.S. government is also poised to hit the legal limit on its debt Monday, and while the Treasury Department will begin taking "extraordinary measures" to postpone default, that financial engineering will only buy about two months' time. President Obama has said he will not negotiate to secure an increase in the debt ceiling, but Republicans insist that any move to raise the borrowing limit must be accompanied by an equal amount in spending cuts. Those positions set up the possibility of another battle that could shake investor confidence.

"In the most extreme case, where we went deeper into 2013 – not by a day, not by a week, but going into the first couple of months of 2013 without resolution" – and with the debt ceiling also unresolved, says Luschini – "then I think that would lead to a pretty severe market riot." He suggests that the S&P 500 could drop to around 1,250 – about 11 percent below where it closed on Friday and some 15 percent off where it had been mid-month. If, on the other hand, lawmakers can pull out a deal, Luschini and other analysts say the prospects for continued market gains in 2013 look strong.

One other market measure may be worth keeping in mind: An old Wall Street adage holds that, "As January goes, so goes the year." Investors heed such sayings over more rational analyses at their own peril, but this one has held true in 61 of the past 84 years. In this case, if the nation goes over the fiscal cliff for an extended period of time – and the economy hits the rocks as a result – there may be good reason to heed that January barometer.

Editor's Note: This article by Yuval Rosenberg originally appeared on The Fiscal Times.

For more from The Fiscal Times:


Cliff Drama's Final Act Brings Biden on Board

GOP May Lose a Lot More Than Cliff Tax War

Health Care Reform Changes Coming in 2013


Follow The Fiscal Times on Twitter @TheFiscalTimes.
No positions in stocks mentioned.
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