By Jack N., Communications Analyst and Blog Contributor
The president and congressional Republicans appear to be making progress on the so-called fiscal cliff, which has consumed our attention for weeks now. In fact, I just Googled “fiscal cliff” and it received 13.2 million results. That’s not in “Kim Kardashian” territory (141 million hits), but it’s impressive.
But is the fiscal cliff much ado about nothing, especially now that a deal appears to be imminent? No way. There are too many components and too many possible “fixes” for anyone to let their guard down.
Fiscal cliff overview
If you’re unsure what the fiscal cliff is, let me offer a short overview. In August of 2011, Congress and the president couldn’t come to terms on a plan to raise the federal debt ceiling and reduce the federal deficit. The ceiling ultimately was raised after both sides set in motion a series of major spending cuts and tax increases that automatically take effect Jan. 1, 2013. A lot of really smart people, including the non-partisan Congressional Budget Office, say that the combination of tax hikes and spending cuts would likely throw the country back into a recession.
How to prepare for the fiscal cliff?
In general, here are the primary questions traders and investors are likely to ask themselves about the fiscal cliff:
- Will it lead to a massive reduction in government spending at a time when the economy can ill afford a reduction in any spending?
- Will it lead to tax increases at a time when the economy can ill afford an increase in taxes?
- Will any solution lead to long-term economic stability?
- Where should I put my money today?
I’ll answer question four, first. Unless you’re psychic or you have the inside track into the minds of our country’s leaders, bailing out on your investment or trading plan makes no sense.
Opportunity for traders
Traders could have a field day if speculation and rumors fuel quick market moves. For example, look at a chart of the VIX index below, which tracks volatility in the S&P 500. This so-called “fear index” tends to rise when uncertainty grows. The spike in August 2011 coincides with concern over the impasse in raising the federal debt ceiling. In fact, for about a week in early August, trading volume at Scottrade nearly doubled its 2011 average. Volatility became subdued shortly after the debt ceiling was resolved through the automatic spending cuts and tax increases that now comprise the “fiscal cliff.”
Whether you’re tracking the VIX or other indicators, consider letting your fundamental analysis or your technical charts be your guide.
Investors stay the course
Investors, on the other hand, shouldn’t panic. If stocks plunge, then the fixed-income portion of your portfolio might help cushion the blow. If you’re worried that you’re overexposed to something that could crash if the fiscal cliff is breached, then you’ve just told yourself that your portfolio might be too risky. Let diversification be your guide.
I think questions one through three, while provocative and important, are largely irrelevant to traders and investors who have a plan in place. If you don’t have a plan, this would be a good time to start.
What are you doing to prepare your trading or portfolio for the fiscal cliff’s verdict?
Jack N. is a communications analyst at Scottrade. He works to demystify the markets and the economy for all types of investors and traders.
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Articles, commentary, and opinions expressed on this site are those of the author and not necessarily those of Scottrade. Scottrade does not guarantee the accuracy of, or endorse, the views or opinions of the author.
The examples and/or strategies described in this blog are for informational purposes only and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.
Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market.
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