The Stock Market Doesn’t Care About the Fiscal Cliff
Thursday marked Day 23 of the Fiscal-Cliff Hostage Situation. Vanquished Republican presidential candidate Mitt Romney came to lunch at the White House. House Speaker John Boehner and Senate Majority Leader Harry Reid stuck out their tongues at one another. The hostages—the Bush-era tax rates on income, capital gains, and dividends, and the defense and other budgets subject to sequestration— remained locked up in Washington. And in New York, investors reacted poorly to the news. “Stock gains dented over twists in budget talks,” as the MSN Money headline put it.
Let’s step back for a minute.
If you’re trading stocks based on whether you think taxes will go up on January 1, 2013, or whether it seems more or less likely that Congress and the Obama administration will strike some grand bargain on entitlements and taxes in the next few days—well, you’re not too sharp. And if you’re in turn basing those decisions on what public officials are saying about the prospects of such a deal, then you’re kind of a dope.
Stock trading is a fool’s game to begin with. Very few investors can beat the market. The market is dominated by insane, hyperactive machines that frequently don’t know what they are doing. Professionals mostly fail at beating the indices. And a bunch of those who do, we’re learning, are clumsy cheaters. (Pro tip: if you’re IM’ing about insider trading, don’t use phrases like “I don’t want to go jail.”)
Watching and reacting to what Congress people say about the cliff negotiations and the prospects of a deal won’t give you an edge—regardless of what the headline writers say. Why? Well, the overwhelming majority of stuff that elected officials say to the public is bulls--t. What they say has no bearing—frequently on the truth, or on whether a deal will get done. When someone says they’re optimistic about something about to happen, they could be genuinely optimistic—or they could be full of it.
Also, investors don’t seem to be very good at figuring out who really matters in these debates. The other day, CNBC’s Michele Caruso-Cabrera told a Democratic House member, Raul Grijalva, that his remarks against concessions on entitlements were making the stock market go down. Grijalva is a member of the minority in the House; most investors had likely never heard of him before his appearance.
More broadly, the market—and many of those who interpret the market’s mind on our behalf—have an extremely simplistic and wrongheaded view of what is good for it. The conventional investing wisdom assumes that a deal—any deal—to avert the fiscal cliff will be good for stocks and the economy at large. That may be true. It may also not be true. In fact, I suspect that at the end of the day the people who are agitating most ardently for a big deal are going to be very disappointed. Compared with a few weeks ago, we are much less likely to have major entitlement reform and more likely to have large tax increases on the rich, with marginal rates rising, taxes on capital gains and dividends rising, and the rich losing some of their cherished deductions. The investor class has been begging for a resolution. The resolution they’re likely to get could be a sharp slap in the face.
Will that be good for stocks in 2013 and beyond? Who knows? In fact, hiking taxes significantly on investors may not influence the markets at all. My colleagues in the politico-financial industrial complex vastly, vastly overvalue the relation of government policy and marginal tax rates to asset prices in the stock market—especially my colleagues on the right side of the aisle.
Twenty years ago, while at my first financial news job, in the midst of the 1992 presidential campaign, I called a bunch of market strategists and asked what would happen if Clinton won. Came the response: that would be a negative sign for stocks because Clinton would raise taxes on the rich, and because he’s a Democrat, and Democrats are bad for stocks. When I called analysts to find out which individual stocks might do well under Clinton, I got responses like: buy HMOs, because he’s going to do universal health care; buy Caterpillar, because there’s going to be a big infrastructure bill. Everything these analysts told me was wrong. Clinton raised taxes on the rich, but stocks rose steadily throughout the two Clinton terms, as the chart below shows. Neither universal health care nor a big infrastructure package was passed. The best-performing stock of the Clinton years turned out to be Dell, whose performance had nothing to do with policy, and everything to do with the Internet (which didn’t exist in 1992) and the rise of China as a cheap place to make computer components.
Eight years later, some of the same people said that stocks would do really well under the Bush administration, because he had pledged to cut taxes on income, capital gains, and dividends, and because he would be more friendly to business. Bush did manage to cut taxes, and he was friendly to business. But the stock market muddled along during the Bush years, as the chart below shows, for reasons that have nothing to do with tax rates.
If you let politics and views on policy dictate your investment decisions—selling stocks when socialist Democrats enter office and buying them when free-market-loving Republicans come in—then over the past 20 years, you would have missed a historic bull-market, then invested and held on for an eight-year nothing-burger topped by a monstrous collapse, then sold just in time to miss out on the three-year, rip-your-face-off rally. (See chart below.)
The case for trading stocks based on a cliff deal may be motivated less by ideology and more by a sense that markets perform better when confidence rises and uncertainty is removed. That may be true. And, yes, the fiscal cliff is a source of uncertainty. But there are many sources of uncertainty out there—the future of China, the European crisis, war in the Middle East, the weather, various other known and unknown problems. All of them will likely influence stock prices far more in the next few years and the next few months than the resolution of the fiscal cliff.
There’s much, much more to life, and to investing, than tax rates.