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Avery Shenfeld, chief economist at CIBC World Markets (Darren Calabrese For The Globe and Mail)
Avery Shenfeld, chief economist at CIBC World Markets (Darren Calabrese For The Globe and Mail)

Don’t blame the fiscal cliff Add to ...

In my market story on Thursday, I tried (and failed) to get a handle on why markets were choosing October and November to sell off. After all, the fiscal cliff and the European recession aren’t new – and polls had put Barack Obama in the lead during most of the U.S. presidential campaign.

In short, there doesn’t seem to be a lot of surprising developments for investors to think about and recoil from, which suggests that markets may be caught in an irrational snit.

Avery Shenfeld, chief economist at CIBC World Markets, has, thankfully, addressed this issue in a note on Friday, asking: Why now?

As he argues, the fiscal cliff (the automatic tax increases and spending cuts coming in the New Year should politicians not agree on a budget) has been in the market’s sights for months. And even though stocks have turned particularly rough since Mr. Obama’s re-election earlier this month, his tilt toward regulations and tax increases should have been priced in before the first presidential debate.

However, Mr. Shenfeld believes there are at least two compelling reasons behind the market decline: earnings and Europe.

“Third-quarter earnings for the S&P 500 have done little to inspire, and the guidance for the fourth quarter looks downright ugly, with nearly four downgrades for every upgrade,” he said in a note.

The third-quarter reporting season began with Alcoa Inc. on Oct. 9 (the company cut its forecast for aluminum demand) and ended with Wal-Mart Stores Inc. on Thursday (its fourth-quarter outlook was shy of expectations). Over the course of this reporting season, the S&P 500 fell 6.1 per cent, which is the worst earnings-season dip since the first-quarter reporting season in 2010.

On Europe, Mr. Shenfeld sees darkening clouds, which is bad news, given that the region accounts for about 15 per cent of S&P 500 profits: “Euro zone GDP didn’t do any worse than expected in Q3, but higher frequency data bodes ill for Q4,” he said.

That helps in explaining “why now?” As for “what’s next?” Mr. Shenfeld isn’t optimistic that a resolution to the fiscal cliff, on its own, is going to accelerate economic growth or reignite the bull market.

“For that, we will need more progress in lightening up on Europe’s own fiscal cliff (one it jumped over, unfortunately), stimulus to kick in in China, and the U.S. to get through enough of its still measurable fiscal drag in 2013 to have investors looking ahead to better times in 2014,” he said.

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  • S&P 500 INDEX
  • Updated May 31 4:49 PM EDT. Delayed by at least 15 minutes.

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