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Expectations, Uncertainty, and the 'Fiscal Cliff'

September 5, 2012 3 minute Read by John Prestbo

The “fiscal cliff” of tax hikes and federal spending cuts that we’re due to fall over on January 1 is starting to be taken seriously in the investment community. It remains the most major immediate barrier to accelerating U.S. economic growth. Up to now, sporadic articles have flashed red lights and warned of danger ahead. Now that Labor Day has gone we can expect to see more and more alerts in newspapers, magazines, online, and on TV and radio. It will be interesting to see how this dire flood of media influences the presidential and congressional elections. “Countdown to a Tax Hike,” was the lead headline on The Wall Street Journal’s Weekend Investor page over the holiday weekend. The article forecasts “a wild ride” but urges readers not to panic…yet. Sample advice: Don’t sell all investments with paper profits simply to avoid the possibility of paying higher capital gains taxes in 2013. Instead, “sell only those assets you already were planning to sell — but do it before the end of the year.” Just below that cheery article was another provocative headline: “Election or Not, Stocks Seem Poised for Trouble in 2013.” Columnist Jack Hough noted that no matter which party wins, “the president and Congress in 2013 will come under intense political pressure” to cut the federal debt through higher taxes, reduced spending or both. And any choice could subtract from growth in the near term. His conclusion: “Cautious investors might want to take some money off the table” until the “tumultuous period for stocks” is over. Elsewhere in that same issue of the Journal, Jason Zweig reported on a curious new market phenomenon: Some companies that reported worse earnings than analysts had forecast were seeing their stocks rise, rather than fall as usually is the case. Why? Because even though lower, the earnings weren’t as bad as some had feared. Zweig cited research that found “what determines how an investor’s brain responds to an earnings report isn’t the size of the company’s gain or loss, but whether the gain or loss is better or worse than expected.” Expectations are indeed a powerful influence on behavior. To get this country growing again, people need to expect clear rules, fair treatment, and logical incentives. The uncertainty of the fast-approaching fiscal cliff leaves them in no mood to think big or take risks. We’re all the poorer for it.


Author

John Prestbo
John Prestbo

2012 Economic Growth Fellow

John Prestbo is retired as editor and executive director of Dow Jones Indexes. Previously he was markets editor at The Wall Street Journal. He has co-authored or edited several books over the past 30 years. The most recent is “The Market’s Measure: An Illustrated History of America Told Through the Dow Jones Industrial Average,” published in 1999 by Dow Jones Indexes. His column, Indexed Investor, appears on the highly regarded “MarketWatch” business and finance website. He received his bachelor's and master's degrees from Northwestern University.

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