Fiscal Cliff Avoided, Debt Ceiling Up Next

The Dow Jones Industrial Average (Dow) rose 3.84%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 4.70%, the Standard & Poor’s 500® Index (S&P 500) gained 4.57% and the NASDAQ Composite Index (NASDAQ) tacked on 4.77%. Sector breadth was positive as all 10 of the S&P sector groups finished higher.

January 07, 2013    |    By Mike Schwager

Performance for Week Ending 1/4/13:

The Dow Jones Industrial Average (Dow) rose 3.84%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 4.70%, the Standard & Poor’s 500® Index (S&P 500) gained 4.57% and the NASDAQ Composite Index (NASDAQ) tacked on 4.77%. Sector breadth was positive as all 10 of the S&P sector groups finished higher. The Energy sector (+5.47%) led the way higher followed by the Financials (+5.44%) and Industrials (4.98%) sectors.

Index* Closing Price 1/4/2013 Percentage Change for Week Ending 1/4/2013 Year-to-Date Percentage Change Through 1/4/2013





Wilshire 5000




S&P 500








*See Last Page for Index Definitions

MARKET OBSERVATIONS: 12/31/12 - 1/4/13

The major market indices finished the week broadly higher after U.S. policymakers passed a bill to avert the fiscal cliff. The market has been held hostage over the past few months reflecting the political brinkmanship in Washington and the resulting uncertainty over whether a resolution would be reached. While the reaction to the news is always more important than the actual news, the relief rally staged by the markets was likely explained on the much desired clarity on taxation. With that said, the enthusiasm surrounding the deal could prove short lived as lawmakers failed to address the looming budget ceiling (being referred to as the second fiscal cliff). The risk of inaction was underscored after rating agency Moody’s said that if Congress doesn't do more in the coming months they could follow Standard & Poor's in downgrading the U.S. debt rating.  In other words, as was the case for most of 2012, the biggest risk to the markets in the near-term remains political.

Basic details of the deal included a hike in marginal tax rate to 39.6% (from 35%) for incomes over $400K (individuals)/$450K (families) and a permanent extension of the Bush marginal rates for incomes under $400K. The deal also included an extension of unemployment benefits for one year, a permanent  fix for the alternative minimum tax (AMT), a bump to 20% from 15 % on capital gains and dividends taxes for high earners and a delay of two months in the sequester of spending cuts. 

While many were hoping that an extension of the debt ceiling would be part of the initial deal, lawmakers choose to kick the discussion down the road and will address the situation in the weeks to come. The debt ceiling negotiations could prove more toxic than the fiscal cliff debate and failure to agree could prove more catastrophic. While fully going over the fiscal cliff (higher taxes for almost everyone and sharp spending cuts) would have likely resulted in the U.S. economy falling into recession, failure to raise the debt ceiling could have global ramifications. According to a recently published report by the Treasury Department, “If Congress fails to increase the debt limit the government would default on its legal obligations – an event unprecedented in American history. This would cause investors here and around the world to doubt, for the first time, whether the United States will meet its commitments. That would precipitate a self-inflicted financial crisis potentially more severe than the one from which we are now recovering.”

If there was a silver lining in the fiscal cliff negotiations it was the knowledge that when push comes to shove, policymakers will likely “break” and find resolve. This suggests that the upcoming debt ceiling debate could be resolved before it shuts down the economy (likely in the 11th hour) … We’ll see — until then expect volatility to remain elevated.

Payroll Report
On Friday, the Labor Department reported that nonfarm payrolls in December rose by 155K, in slightly ahead of the 152K estimate. The unemployment rate during the month rose to 7.8% (from 7.7%) while private payrolls—which filter out government hiring/firing—rose by 168K, solidly ahead of the 155K estimate.  Also noteworthy is the upward revision to the November data where nonfarm payrolls were revised to +161K (from 146K) and private payrolls rose by +171K up from the original estimate of 147K.  

While the strength in payrolls are still falling below levels needed to bring the unemployment rate moderately lower, the additions over the past couple months suggest that the political wrangling over the fiscal cliff had only minimal impact on hiring decisions.

FOMC Meeting Minutes
On Thursday the meeting minutes from the December 11 & 12 Federal Open Market Committee (FOMC) were released. While the minutes suggested that there was broad support for the FED's most recent plan to buy additional Treasury bonds to support the U.S. economy, policymakers differed over how long to keep the program in place. According to the minutes, a “few” of the 12 voting FOMC members wanted to keep buying assets until the end of 2013. They are backed by a “few” more who want “considerable accommodation” but did not set a date. But “several” other members want “to slow or to stop purchases well before the end of 2013” and one member opposes them altogether.

Both stocks and U.S. Treasuries pulled back in reaction to the release with the yield on the 10-year Treasury rising to an 8-month high (yields and price move in opposite directions). The FED has been the major buyer of U.S. government debt and the minutes suggest that their bond buying activity will likely end sooner than the market was anticipating. While the bond buying program could end sometime later this year, the FED’s pledge to keep rates low until unemployment dips below 6.5% or inflation exceeds 2.5% remains intact. With that said, it should be noted that markets are discount mechanisms, meaning that bond yields will likely rise well ahead of any “official” change by the FED as investors begin discounting higher rates.

Economic Round-up
Last week’s batch of economic data continued to suggest the U.S. economy remains on firm footing. Reports of note include the Institute for Supply Management (ISM) manufacturing report that showed the U.S. manufacturing sector returned to the expansionary zone. The ISM also reported that the non-manufacturing (services) sector in December rose at the fastest pace in 10 months. The services sector benefitted from a solid holiday shopping season and the improvement in the housing sector. With service oriented businesses comprising 90% of the U.S. economy, the report suggests the economy has solid momentum heading into the New Year. On the labor front, in addition to the better than expected monthly payroll report, the monthly employment change report from payroll processor ADP showed U.S. corporations added an estimated 215K jobs during the month of December, solidly ahead of the 140K gain expected by economists and the best reading since February.

The Week Ahead:
News flow out of Washington will likely take center stage again this week as investors wait for more clarity on the fiscal front.  On the economic front, the calendar is backend loaded with the bulk of the data not due out until Thursday and Friday. Reports of interest include small business optimism, jobless claims, wholesale inventories and the trade balance. Fourth quarter earnings season kicks off in earnest this week when Dow-component Alcoa reports results on Tuesday. Peak earnings season still remains a few weeks away although many bellwether companies are scheduled to release results over the next couple weeks. Other events of interest include a handful of appearances by FED officials and the first meeting of the European Central Bank since President Mario Draghi opened the door to lower interest rates a month ago.


While fiscal uncertainty will remain a near-term headwind, expectations of an eventual agreement on the debt ceiling should set the stage for higher asset prices. Domestic growth has been gaining traction reflecting the resiliency of the consumer and the improving labor market and housing sector. While the political “noise” will dominate the investment landscape in the near-term, equities remain attractive on a longer term basis reflecting the combination of attractive valuation, the overall healthy nature of corporate balance sheets and the commitment from the FED to maintain accommodative monetary policy for the foreseeable future.


The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Nasdaq Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

The S&P/TSX Composite Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange (TSX). The index was developed with a base level of 1000 as of 1975.


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