Stocks in for losses on worries political gridlock will derail fiscal cliff deal

TORONTO – Stock markets look set for a steady drip of losses in the near future as traders worry that American lawmakers won’t be able to avoid a series of damaging spending cuts and tax increases coming into effect at the beginning of next year.

Worries about the impending fiscal cliff sent North American markets lower last week after traders immediately turned their attention from a fierce election campaign that essentially left the American political landscape unchanged to the looming deadline.

The TSX ended the week down 183.61 points or 1.48 per cent while the Dow fell 277.77 points or 2.12 per cent.

The fiscal cliff label refers to a string of tax increases and steep spending cuts aimed at cutting the deficit which are set to take effect at the first of the year. If they are allowed to take full effect, the cuts and tax increases will total about at least half a trillion dollars and take a big chunk out of GDP, in 2013. Failure to come up with a compromise would likely tip the U.S. back into recession and drag down other economies with it.

Bank of Canada governor Mark Carney says the fiscal cliff is the most imminent threat facing the Canadian economy.

Traders found little comfort from an announcement by President Barack Obama Friday that he is inviting congressional and business leaders to a meeting next for talks aimed at finding a compromise.

But he made it clear that spending cuts must be combined with new revenue, adding he would not accept any approach that isn’t balanced and doesn’t include the wealthy paying more taxes.

Losses were deeper on U.S. markets as traders weighed the odds of much higher tax rates on dividends and capital gains.

“People woke up Wednesday morning and those who have meaningful investment positions said OK, nothing has really changed in the government so it looks like tax rates will be going up, one way or another,” said Norman Raschkowan, North American strategist at Mackenzie Financial Corp.

“And you have to consider that the tax rate on capital gains in the U.S. is 15 per cent (the same as the tax rate on dividends). And the Democrats are suggesting the tax rates should be closer to the rate that’s paid on regular income and interest income and so on.”

He pointed out that the U.S. market has come a long way since hitting bottom in March, 2009, leaving many investors with strong gains on their portfolios.

“And they’re going to say, maybe I’ll take those gains now at the 15 per cent tax rate rather than risk taking them next year at whatever the higher rate is. And people who bought these stocks for the dividends are suddenly saying, maybe they’re not quite as attractive,” he said.

A major reason for the lack of confidence in American lawmakers is that traders recall the fierce infighting that went on during the debate on raising the U.S. debt limit during the summer of 2011. The raucous debate pressured financial markets around the world.

It’s not just Americans who are more inclined to sell these days. Canadians are also finding that the U.S. isn’t as attractive as it was earlier this year.

“In our portfolios, I’ve been very bullish on the U.S. and up to now, and I still think longer-term, it will do well,” said Sadiq Adatia, chief investment officer at Sun Life Global Investment.

“But for the next three months now, I’m taking off a little bit of my bet on the U.S., hedging it by putting some (money) in Canada because I think if the fiscal cliff doesn’t get resolved, I don’t want to be significantly overweight. If it does, I can get back into my position right away.”

At the same time, market analysts make clear that they can’t believe there won’t be an agreement, even it comes at a minute before midnight.

“I have to believe that common sense is going to prevail and there will be, both sides will say, look, we do have to compromise here, let’s find a way and they’ll do something because they both realize how they’re holding the economy back,” said Jim Muir, director at Fraser Mackenzie.

“I can’t believe that these politicians would be that stupid.”