Crisis averted for now by U.S. politicians but America is far from out of the woods…

Happy New Year readers!

An optimistic start to trading in 2013 with a 90 point gain right off the bat this morning in the FTSE 100 driven by relief that U.S. politicians finally got their act together and reached a last minute deal to avert the fiscal cliff. 

After the Senate had backed the deal between President Obama and key Republicans by a margin of 89 to 8, the House of Representatives passed a bill by 257 to 167 votes to halt around $550 billion of cuts in government spending and $109 billion in tax increases, though most Republicans voted against the bill. The compromise involved extending tax cuts to those individuals earning under $400,000 a year and couples earning $450,000 – up from Obama’s target of $250,000 and taking their rate on income over those amounts to 39.6% from 35%. There was also an increase in taxes on capital gains and dividends from 15% to 20% and an increase on tax rates on estates worth more than $5m, from 35% to 40%. Finally there was the end of a 2 percentage point cut in payroll taxes for employees first $113,700 of income.  The deal will mean over the next 10 years the wealthiest members of US society will swallow a $620 billion tax increase.

Though the compromise deal is undoubtedly good news for the U.S. economy, the financial mess and associated uncertainty is still very much on the agenda. The bad news was that there was confirmation on Monday that U.S. debt had reached its legal borrowing limit on December 31st . Treasury Secretary Tim Geithner announced he had begun a “debt issuance suspension period” that would last until the end of February meaning the U.S. Treasury will employ a series of “extraordinary measures” such as suspending the reinvestment of federal workers’ retirement account contributions so it does not exceed the debt limit of $16.394 trillion. 

So today’s rally in equity markets may yet be overshadowed by the continued uncertainty in coming weeks around the next chapter in the fight between U.S. politicans around the debt ceiling. We all know that investors hate uncertainty and how scrappy and ineffectual US politicians are..!

Though looking at the risks to the global economy this year, they seem to have abated versus the real fear of a eurozone melt down in 2012 and a hard landing for the Chinese economy. The key event for the eurozone in 2012 was the European Central Bank’s and Mario Draghi’s commitment to do “whatever it takes” to save the euro and its pledge of potentially unlimited government bond buying.

With the new Liberal Democrat government in Japan apparently committed to urging the Bank of Japan to deploy whatever it takes to finally stir the economy out of its slumber and the Federal Reserve continuing to throw unprecedented levels of quantitative easing at the American economy, these appear to be a significant back stop to sentiment. 

In addition, with ultra cheap money here for the foreseeable future as a result of a commitment by the Fed and European Central bank to keep interest rates low and continued talk of a rotation out of bonds to equities as a result of their abysmal yields, the risks of a major correction seem remote for now. However, the case for major gains early in 2013 seems less robust after the strong performance in 2012, unless the likes of China surprise with yet another round of massive stimulus thus helping to put a floor on commodity prices once and for all.  

Steady as she goes for now I would reckon… but things may become more hairy once the American Politicians slug it out in February to agree a compromise to raise the U.S. debt ceiling. After the fiscal cliff, everyone agrees that any deal won’t come easily.

The balance of probabilities seem to be against a major further rally in equity prices in the first quarter, but there’s one thing that’s a constant at the moment and that’s the difficulty in predicting the markets against the backdrop of consistent volatility. Consensus is usually wrong… With the Federal Reserve, Bank of Japan and European Central Bank seemingly protecting the downside, there seems to be a sense of cautious optimism in many circles for the year ahead. But when everyone is universally bullish just like in 2007, its often the time to take the contrarian view!

Contrarian Investor UK