Over the Cliff and Into the Woods We Go

Can you believe those guys on Capitol Hill? Yet it’s said that people get the government they deserve, leading me to think that Santa – who looks set to give Wall Street a miss this year – must have left an awful lot of coal behind this year.

As of Friday’s close, the S&P is off 1% for the month of December, historically the second best month of the year for markets. On the one hand, futures continued to sell off after the close. On the other, a deal Monday – and I make no prediction – could give us a rally that would wipe out the month’s loss with room to spare.

I do believe that at some point over the next week or so, some sort of patchwork, interim arrangement will be reached. It seems more likely to happen after the deadline, so that Republicans can vote for a tax decrease and Democrats don’t have to accept cuts to the safety net. In any case, once a deal is reached, markets should rally for a day or three, unless the deal is too late and too ugly.

It won’t matter though, not for long. I am convinced that the real budget battle, catalyzed by the debt ceiling, is going to be an ugly partisan brawl that will cause stock prices to sink. For a fuller discussion, see my article on the subject at Seeking Alpha. For a good discussion of why the two parties may go over the cliff for at least a few days, check out the following story at politico.com.

One prediction I will make here is that if an interim agreement is reached, it will make the latter stage more contentious. Whatever ground is given in the first stage, each party will seek to reclaim in the second. As far as I can tell, the major concessions that each party strenuously claims to be willing to make consist of moving from the extreme wing of their own party to the center – of their own party. That still leaves a rather significant divide.

It’s no way to start the year, not with a European recession still cooking. Even so, our own economy should weather the storm over time. I wish all MarketWeek readers and their loved ones a happy and prosperous 2013. Markets close early on Monday and all day Tuesday.

The Economic Beat

Housing continues to improve, although at a rate that is far more modest than the media coverage would have you believe. New home sales rose to a seasonally adjusted 377K, a number I suspect will be revised downward somewhat. Pending home sales rose by 1.7%, and the Case-Shiller home price index showed a year-year gain (through October) of 4.3%.

It appears that the growth in Christmas sales will be the weakest since 2008. There are plenty of anecdotes in the press attributing cliff-caution to the consumer, but the effect is difficult to isolate and we won’t know for some time. Consumer confidence fell sharply, though the decline was based entirely on the outlook, a finding that should come as a surprise to no one. The present conditions index rose. Weekly jobless claims are likely to be revised as well, as 19 states sent in estimated data last week.

The Chicago PMI reported a slight increase to 51.6, seasonally adjusted. New orders recovered smartly. The Richmond Fed reported a small positive reading (5) for its manufacturing index.

In case you haven’t heard, Japan is rallying on the back of its new determination to devalue the yen. It won’t do if everyone tries to devalue at once, but I suppose that’s a problem for 2013.

Next week starts with the China PMI over the weekend. After what could be an exciting last day of the year and the holiday, Wednesday starts the market year off with a bang that may or may not include more fireworks from Washington. We’ll get auto sales, the ISM manufacturing index and the FOMC (Fed) minutes, along with construction spending. Thursday will bring December same-store sales reports (albeit a flawed sample) and the ADP employment report, along with last week’s claims revision (should be a big one). Friday will have the last jobs report of 2012, though I expect December to end up catching a couple of revisions. The ISM non-manufacturing index also comes out Friday morning.

Happy New Year!