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'Fiscal cliff' fears may extend stocks' decline

'Fiscal cliff,' recession in Europe and the U.S. economy are weighing on investors. The Dow and S&P 500 index could be next to fall into correction territory.

November 16, 2012|By Andrew Tangel, Los Angeles Times
  • The Dow industrial average and the Standard & Poor’s 500 index are each down more than 2% this week, wiping about $385 billion of value from U.S. stocks. Above, traders work on the floor of the New York Stock Exchange.
The Dow industrial average and the Standard & Poor’s 500 index… (Spencer Platt, Getty Images )

NEW YORK — Fears about continued gridlock in Washington about impending tax increases and spending cuts have some on Wall Street fearing that stocks will continue to slump through the holidays.

The technology-heavy Nasdaq composite index and the Russell 2000 index of small-cap stocks have entered into a correction, falling more than 10% from their mid-September highs. Both roared earlier in the year as investors snapped up riskier stocks in hopes of a big market rally.

Quiz: How much do you know about the 'fiscal cliff'?

The sudden shift in investor sentiment has analysts fearing the market's biggest stock market gauges — the Dow Jones industrial average and Standard & Poor's 500 index — might be the next to descend into correction territory. Both are down more than 2% this week, wiping about $385 billion of value from U.S. stocks.

There's been a confluence of bad news that has spooked investors, including Europe slipping into another recession and worries about the economic recovery in the U.S. But the biggest weight on the market is what President Obama and Congress will do about the "fiscal cliff" that is scheduled to begin after the new year.

"I see very little to be optimistic about right now until we get some more clarity on these pressing issues," said Randy Frederick, managing director of active trading and derivatives at Charles Schwab & Co. "They've become a little bit less cooperative and sound a whole lot more like they were sounding last year."

Wall Street had predicted President Obama's reelection would lead to continued gridlock with a Republican-controlled House. But posturing ahead of the president's meeting with congressional leaders Friday at the White House has fueled doubts that Washington will avert a fiscal crisis. Among those that will be in attendance is House Speaker John A. Boehner (R-Ohio), who has gone on record that he won't back raising tax rates.

Investors may not be offloading stocks merely because they worry that an unresolved fiscal cliff could push the U.S. back into recession. Scheduled to go into effect are increases in taxes on capital gains — profits from how much stocks appreciate in value — and dividends. Many large institutional investors are offloading shares before year's end to avoid paying a higher tax bill in 2013, said Doug Cote, chief market strategist for ING U.S. Investment Management in New York.

"What's happening with the market is an orderly harvesting of capital gains," Cote said, noting that mutual funds and hedge funds have been selling off positions over weeks, not all at once. "Institutions are not waiting for the signal" that the fiscal cliff will be resolved, Cote added. "The institutions are assuming it's the law of the land and we're out of time."

Certainly, if Obama and Congress strike a deal to resolve issues surrounding the fiscal cliff before Dec. 31, analysts predict, the markets could see a year-end rally.

Major stock indexes have been sliding since Obama's reelection last week. The Dow Jones industrial average closed down for the fourth straight day, shedding 28.57 points, or 0.2%, to 12,542.40. The blue chip index lost nearly 200 points the previous day.

The broader S&P 500 lost 2.16 points, or 0.2%, to 1,353.33, while the tech-heavy and generally more volatile Nasdaq fell 9.87 points, or 0.4%, to 2,836.94.

Nevertheless, some large Wall Street banks have been predicting the benchmark S&P 500 would decline about 10% or more from its Sept. 14 high of 1,466.

Goldman Sachs, in a Nov. 9 research note, predicted the S&P 500 would close the year at 1,250 — that would be a 15% drop from its high. Even if Washington succeeds in averting a fiscal crisis, the uncertainty has reportedly paralyzed corporate decision-making.

Earnings estimates for the fourth quarter have declined sharply. On Oct. 1, analysts estimated the average company in the S&P 500 would have earnings growth of 9.6% in the fourth quarter, according to S&P Capital IQ. As of Thursday, analysts expected average profits to grow 5.3%.

"Corporations need clarity," Frederick said. "If they have clarity they'll spend, they'll hire, they'll invest in machinery, computers, whatever. But we're running out of time for that to happen."

What also might be hampering growth is economic uncertainty in the U.S. and Europe.

Consumer spending during the holiday shopping season will shed some light on the U.S. economy's health. So too will the U.S. Labor Department's November unemployment report, which is due out early next month.

But this week, U.S. economic data pointed to continued sluggishness. Initial jobless benefit claims unexpectedly jumped 78,000 to 439,000 last week, compared with the previous week.

The increase in unemployment claims was partially attributed to Superstorm Sandy, which also slowed manufacturing and business activity on the East Coast, according to reports released Thursday by Federal Reserve banks of New York and Philadelphia.

Worries about Europe's economy also dent corporate earnings because roughly half the sales in S&P 500 companies come from abroad, according to Christine Short, senior manager at S&P Capital IQ in New York. And now worries over the fiscal cliff threaten to undercut the tenuous U.S. recovery.

"Europe isn't getting any better, and China is indeed slowing," Short said. "The fiscal cliff is a big worry. This is something new we haven't had to deal with."

andrew.tangel@latimes.com

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