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What July 2011 Tells Us about the Fiscal Cliff

Ian Wyatt

Let’s go back about 16 months to July 2011.

Adele’s “Rolling in the Deep” topped the Billboard charts. “Cowboys & Aliens” was No. 1 at the box office. And the Boston Red Sox appeared well on their way to a third world championship in eight years. (OK, maybe that last one was a stretch.)

Oh, and the U.S. government was on the precipice of exceeding its $14.3 trillion debt ceiling, the consequences of which would have been catastrophic. The U.S. government would have defaulted on its debt and been unable to pay all of its bills.

The August 2 deadline to raise the debt ceiling was nearing, and as usual, Republicans and Democrats couldn’t agree on a compromise.

As the two sides bickered all the way through the end of July, stocks suffered. Starting on July 23 – with the debt-ceiling deadline 10 days away – U.S. financial markets fell off a cliff (remember that word).

The S&P 500 fell 17% in two weeks. The Dow Jones Industrial Average shed almost 2,000 points. All three U.S. indices hit their lowest point in nearly a year.

The two sides finally came together to hammer out an extremely last-minute deal on August 1. But for investors, the damage had already been done. U.S. markets hadn’t plunged so far so fast since the recession hit in late 2008.

Fast forward to today, and the U.S. once again finds itself on the edge of a cliff. In fact, that’s actually its proper name.

Fiscal cliff is the term economists are using to describe President Obama’s Budget Control Act, which will impose government spending cuts and higher taxes starting on January 1, 2013. If enacted, some say it could plunge the U.S. economy into another recession.

Like 16 months ago, another round of partisan, heated negotiations is sure to drag on right up until the deadline. And just as before the debt-ceiling deadline, investors are fearing the worst.

Last Tuesday’s election gave President Obama four more years in office and kept the same Congress that nearly allowed the country to default two summers ago largely intact. With the fiscal cliff looming, investors aren’t digging the status quo.

Stocks have already fallen 3.5% in the week since the election. The decline comes in what has historically been the market’s most fruitful month.

In presidential election years, November is the best month for the Dow Jones Industrial Average and S&P 500 Index. The Dow climbs by an average of 1.6% in election years. The S&P gains 1.4%.

Usually there’s so much uncertainty in the markets leading up to an election that once a new president has finally been elected, investors go on a collective spending spree. Black Friday and the beginning of the holiday shopping season don’t hurt either.

This year, however, the election transformed investor uncertainty into fear. Even with Black Friday just 10 days away, it seems the fiscal cliff is all anyone can think about.

And with every day that Congress fails to reach a deal to avoid this fiscal cliff, that fear will only grow. It’s what we saw 16 months ago – when investors went into full-on sell-off mode in the 10 days leading up to (and even after) the debt-ceiling deadline.

This year, the stakes are even higher – and the losses could be even greater if Congress drags its feet again.

Investing accordingly,

Ian Wyatt

P.S. Want to speed up the fiscal cliff negotiations? Here’s your chance to do something about it. I am circulating a petition asking Congress to stop the Budget Control Act from going into effect. Click here to sign the petition, and have a copy of it sent directly to your representative in the U.S. Senate.