Despite fiscal deal, investors face imminent obstacles

Outside the New York Stock exchange in New York, Dec. 31, 2012. Economists forecast that an increase in payroll taxes and contin
Outside the New York Stock exchange in New York, Dec. 31, 2012. Economists forecast that an increase in payroll taxes and contin

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With the House of Representatives’ approval of a fiscal agreement late Tuesday, investors were expecting a rally in the markets to start the New Year. But the surge was not expected to last long, with investors and economists quickly shifting their focus to several hurdles the economy faces in the coming months.

“We could see an early lift in the markets because of relief the deal went through,” said Gary Thayer, the chief macro strategist at Wells Fargo Advisors. “The response may be muted because the deal left out many long-term issues.”

Market strategists were forecasting that even the deal approved by the Senate early Tuesday and by the House late Tuesday night would reduce economic growth by as much as 1 percent in the first quarter of 2013. Much of this would come from a rise in payroll taxes on incomes under $113,700 that would affect about 77 percent of American households.

Then there are the fiscal disagreements that Congress did not try to address in its negotiations this week. Spending cuts of $110 billion were delayed for two months, and politicians have not come up with a long-term solution that would allow the government to get past the borrowing limits reached at the end of the year – known as the debt ceiling.

“We keep stumbling from patchwork solution to patchwork solution, without getting us to the longer term solutions we need,” said Michael Gapen, the head of U.S. economic research at Barclays.

Technically, the country went over the so-called fiscal cliff on Tuesday, when markets were closed for the holiday. But the compromise reached later Tuesday should retroactively cancel the tax increases that began.

U.S. stock indexes saw their biggest jump in over a month on Monday in anticipation of a deal moving swiftly through Congress. In early trading on Wednesday, leading indexes rose 2.6 percent in Hong Kong and 1.2 percent in Australia.

“If Congress just comes close to their most modest expectations, investors tend to cheer that,” said Ed Yardeni, the founder of Yardeni Research. “A lot of investors are suffering from battered investor syndrome.”

Many economists say that if politicians are ultimately able to reach a more lasting budget agreement, it could allow the focus to turn to signs of improvement in both the U.S. and global economies. Asian markets have been propelled higher in recent days by data showing that China’s manufacturing sector was continuing to expand. In the U.S., housing prices have been moving higher and unemployment rates lower.

This has led many economists to forecast stronger growth for the second half of 2013 – around 2.5 percent – but only after the weight of the tax increases and budgetary debates are out of the way. In the last few weeks, signs of economic strength have allowed investors to respond with a bit of a shrug to the impasse in Washington. The benchmark Standard & Poor’s 500 stock index ended the month of December up, and finished the year 13.4 percent higher.

Many investors are also likely to be happy with the portions of the congressional agreement that deal with tax rates on dividends, which are now set to rise to 20 percent from 15 percent, less than President Barack Obama had proposed. This could produce some demand for dividend-paying stocks, particularly given that the rates will be put in place permanently.

Congress also surprised some economists by agreeing to extend unemployment benefits for more than 2 million people, and by making changes to the Alternative Minimum Tax that will avert higher tax bills for middle-income households.

But, as expected, Congress decided to allow the payroll tax to rise to 6.2 percent from 4.2 percent. That is likely to immediately crimp the spending power of U.S. consumers, and take about $120 billion out of the economy in 2013.

In the longer term, investor uncertainty heading into the new year underscored the degree to which Wall Street has become consumed by a seemingly never ending series of battles in Washington, in which one budget dispute bleeds into another.

The most severe crisis came in the summer of 2011, the last time the government reached its borrowing limit. Congress ultimately came up with a solution that allowed the government to continue taking on more debt, but only by pushing off the hardest decisions to the end of 2012. The Senate and House votes on Tuesday put off many of those same decisions until March. At that point, the Treasury Department says it will no longer be able to use extraordinary measures to borrow enough money to operate the government.

The compromise this week also delayed $110 billion in cuts to the defense budget and other government programs until March. If there is no further agreement at that point, those cuts will begin to be phased in, amounting to another hit to the economy.

Even if the debt ceiling and budget cuts are resolved in March, politicians could put off again any long-term answer to the ballooning government deficit and debt problems that are most worrisome to many economists.

“The markets are very quickly going to appreciate that this does not remove this cloud of fiscal uncertainty, it just briefly defers it,” said Ian Shepherdson, the chief economist at Pantheon Macroeconomic Advisors. “I can see no reason that debate should be less divisive than the debate we’ve just had.”

© 2012, The New York Times News Service

Story first published on: January 02, 2013 10:53 (IST)

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