Investors shouldn’t take Wednesday’s stock market rally as a green light for stocks, experts warn, as the unfinished business surrounding Washington’s budget wrangling will likely fuel corporate uncertainty and market volatility for months to come.
Although markets erupted with joy as American lawmakers finally agreed on legislation to prevent the most jarring tax hikes and spending cuts that would have resulted from a failure to reach a deal on the federal budget, the agreement falls far short of the “grand bargain” on broader budget issues that President Barack Obama had wanted. Democrats and Republicans now have less than two months to decide on further spending cuts and raise the $16.4-trillion (U.S.) debt ceiling to avoid defaulting.
Analysts said that until a final outcome on the U.S. budget becomes clear, many U.S.-based companies could put off big decisions, and slow or even halt hiring and capital expenditures – creating considerable doubt about the potential for corporate earnings growth this year.
“Companies can’t write their playbook if they don’t know the game,” said Frances Donald, an economist at Pavilion Global Markets in Montreal.
Standoffs over fiscal reforms in Congress “appear to be an ongoing fact of life,” said UBS strategist George Vasic, “which is not good for investor confidence.”
For now, income investors can breathe the biggest sigh of relief. U.S. dividend taxes weren’t increased to 39.6 per cent for high-income households, which would have happened if legislators couldn’t reach a “fiscal cliff” solution. Instead, taxes on dividends will rise only modestly to Clinton-era levels of 20 per cent from 15 per cent for the households with incomes of $450,000 or more, with an additional 3.8 per cent taxed to fund the Affordable Care Act.
Income investors “dodged a bullet there,” said Desjardins Securities market strategist Ed Sollbach. But he nonetheless expects dividend stocks to underperform for the next quarter or two.
As markets began to price in the risk of the fiscal cliff, “people were hiding in the dividend stocks,” Mr. Sollbach said, since such stocks typically outperform in a down market; as relief sets in, they may start to underperform.
Mr. Sollbach predicts at least one return to normalcy in investor behaviour as a result of the “fiscal cliff” deal: He expects investors to return to “the more traditional strategy” of selling weak performers in 2013, after months of selling traditional “winner” stocks like Apple out of fear of higher capital gains taxes. Apple’s long-slumping stock, in fact, jumped 3.2 per cent during Wednesday trading.
While the countdown is on to yet another show-stopping U.S. fiscal deadline, Mr. Sollbach said, “the U.S. isn’t going to default.” He expects another high-stakes drama to go down to the wire in February and March, but says that “crisis fatigue” is setting in among investors. “Ultimately, people realize they’re going to solve this thing,” Mr. Sollbach said.
This means investors should see clearer buying opportunities as details shape up ahead of the next bargaining deadlines.
Mr. Vasic calls himself “moderately constructive” despite his warnings. “There will be plenty of counterpunching opportunities in markets,” he said. While volatility will creep back into markets as the next deadline approaches, he said, “inevitably, they will rise again.”