StanCollender'sCapitalGainsandGames Washington, Wall Street and Everything in Between

Is Wall Street Really This Clueless About The Fiscal Cliff?

18 Nov 2012
Posted by Stan Collender

The Dow Jones Industrials Average was in negative territory on Friday morning when congressional leaders emerged from their first fiscal cliff meeting at the White House. At that point the Dow was down 59 points.

But based on the totally innocuous and meaningless statements from the leaders that the meeting had been "constructive," the Dow rallied significantly. Within an hour, the Dow rose by 104 points from its pre-statement low. It ended up almost 46 points for the day.

Here's what ABC News reported was said by three of the congressional leaders who attended the meeting:

"I believe that we can do this and avert the fiscal cliff that's in front of us today," said (House Speaker John) Boehner.

(Senate Majority Leader Harry) Reid said he felt "very good" about the tenor of the talks. "We have a cornerstones of being able to work something out," he said. "We're both going to have to give up some of the things that we know are a problem."

Both sides agreed to lay out "milestones of success so that confidence can build" among the American people, said (House Minority Leader Nancy) Pelosi. "I feel confident that a solution is in sight."

How is it possible that statements that said nothing, almost certainly were drafted before the meeting began, and were noteworthy only for their polite tone rather than any indication of any substantive progress made such a positive impression on investors and convinced people to buy rather than sell?

Then again...this is the same investment community that rallies when the chairman of the Federal Reserve says in congressional testimony that the Fed is prepared to take steps the deal with the economy if they are if the Fed is ever not prepared to take steps.

Sounds like Henry Kissinger's totally premature statement about the Vietnam peace negotiations that he was starting to see the light at the end of the tunnel. It made everyone feel better about the process even though the substantive progress at that point was very limited and extraordinarily ephemeral.

Wall Street isn't Clueless

Wall Street knows that individual investors and any others subject to capital gains taxes will have to sell their appreciated stock before 31 December to get this year's rate.

Wall Street knows that investors know that if they wait longer than 31 Dec, their tax rate will not be lower than it is now. (Iirc, the long-term [5years or greater] CG tax rate right now is zero; at "worst," it's something like 8%.)

Now, grant that investors subject to CG tax is a very small part of the current market. But all of us are looking at our appreciated stocks and trying to figure out if there's any reasonable way they appreciate enough to make up for the rate going back up to 15 or 20 or 25/28/35--28/31/39.6--and anyone who is not innumerate or really long-term buy-and-hold is taking those gains now.

If a deal goes through and the CG rate doesn't change, the mass selling at the end of the year doesn't happen.

Wall Street is acting rationally, for once.

 Ken...My point was that

 Ken...My point was that nothing that was said on Friday should give anyone any comfort that a deal is more likely to happen. Pure and simple: Wall Street fell for the spin and didn't even seem to realize that it wasm, in fact, spin.

The informative point about

The informative point about these comments is that they are dramatically different from what the same players--and especially Boehner--were saying before the last absurd fiscal legislative drama. The reason the tenor is very different is that it's pretty clear that both Democrats and (sane) Republicans understand that the voting public will blame the Republicans a lot more than the Democrats if we do fall off the "cliff".

This kind of clarity is much more fertile ground for a reasonable deal being made than last time.

Isn't this better than where

Isn't this better than where we were 4 years ago? We've got some serious problems here folks. The shake out is going to suck but the reality out there it is that we continue to live longer and the peeps at the bottom are living better. The thing is you can't control that you keep getting a day older. The future is not yours and for those who think it is you are insignificant.

living longer?

bottom 50 per, life exp gain 1.5 yrs.

top 5.1. sinks in after a while.

numbers not perfect but close.

What I continue to find

What I continue to find amusing is the daily commentary that points to discrete events and or circumstances that drive price action in a given market, particularly stock markets. For example, one headline from this afternoon trying to explain the day's rally in US shares says " Wall St bounces on hopes for budget talk success."

The fact of the matter is that price action is not necessarily attributable to this at all. Today there were more buyers than sellers. On Friday after the morning open, there were more buyers than sellers. For the previous 7 trading days there were more sellers than buyers.

Looking for a causal relationship where none really exists is a waste of time, ink and bandwidth.

"How is it possible that

"How is it possible that statements that said nothing, almost certainly were drafted before the meeting began, and were noteworthy only for their polite tone rather than any indication of any substantive progress made such a positive impression on investors and convinced people to buy rather than sell?"

The answer is that those statements did not have any effect on financial markets. The statements are a factor in financial reporting only. They are not a factor in actual finance.

The reasons why prices move in financial markets are understood only by a very small number of people, and even those few specialists do not understand the markets all of the time. Equity prices represent the market's estimation of the present value of the equity based on financial models, with that value constantly changing in real time as a multitude of factors change.

Sophisticated investment firms employ armies of Ph.D. mathematicians to develop and constantly tweak proprietary financial models intended to incorporate all available information believed to affect stock value. And pricing in the market is driven by real time changes in those financial models, because the models are used to control computer trading.

Only individual investors are reading press releases and making buy-sell decisions on that basis, and their volume, compared to high volume computer trading, is too low to affect market pricing. Unless a major surprise occurs (like 9/11), information is already priced into the market before it becomes available to individual investors. And for that reason, individual investors should limit themselves either to a buy-and-hold strategy or to buying into funds that are capable of sophisticated computer trading.

There is limited value to the standard news report about how daily changes in the Dow Jones Industrial Average are attributable to this or that current news event. Such reporting is a leftover from the days when newspapers ran the business page and the sports page in the same section and wrote business stories for gentlemen who wagered some of their money on the stock market and some of the money at the race track. Even in the 19th century, such reporting was useless. The original purpose of the Dow Jones averages was to provide data points to allow technical market analysts to infer when large industrial enterprises were about to begin to grow. (The idea was, essentially, that if large scale transportation and commodities businesses were experiencing increased growth, then the overall manufacturing economy must be about to do the same.) Then, as now, newspaper stories about the daily changes in Dow Jones averages were after-the fact rationalizations attempting to explain what was not widely understood. The heyday of the Dow Jones averages was also the heyday of the adage, "Buy on rumor, sell on news."

As for the fiscal cliff, everyone knows that some solution will be put into place, because it has to be done. There is some uncertainty as to the precise contours and timing of the solution, and changes in the market's consensus on that uncertainty undoubtedly affect prices in the stock market. The high-volume traders are not reading press releases to get their information. They are speaking (directly or indirectly) to people with actual knowledge of the negotiations. Access to this kind of information is one reason (maybe the main reason) why Wall Street contributes to political campaigns.

Ah, but there was some staff

Ah, but there was some staff chatter reported that does seem to make a difference. Apparently, Boehner told Obama that he wanted a fuzzy agreement on targets for tax revenue and spending cuts, without specifics (don't say "higher marginal rates" till next year, please). This will be declared to satisfy the law and avoid the fiscal cliff, so nobody's taxes go up. Then Boehner starts all over again, after he has been handed the Speaker's gavel for the 113rd Congress.

I would think the acceptability of this deal for Democrats would depend heavily on what it implies for high-earner tax rates and such.

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