Market Beat: The fiscal cliff and stock market volatility
December 18, 2012
TRUCKEE, Calif. – I’m sure everybody’s heard a lot of talk on the fiscal cliff by now. Recently there have been some market analysts advising their clients to be prepared for some volatile market swings due to the fiscal cliff negotiations. Kevin Logan, chief U.S. economist at HSBC, said, “all the debate is mostly about the income taxes and potential spending cuts, but there’s this whole panoply of other items that have to get cleared up.”The Congressional Budget Office has said that letting all of the policies of the fiscal cliff take effect will cause a recession. The fiscal cliff is a package of expiring tax cuts and automatic spending cuts. The Bush tax cuts are a part, as are the payroll tax cut, the AMT patch and the estate tax. Investors are likely to see a change in the capital gains rate and the dividend tax rate.It’s impossible to foresee exactly what our lawmakers will come up with. So, analysts who are paid to determine what the effect will be on the economy have no way of being able to make that determination. As a result when some of the deals are announced, the market could take some large price swings.If you analyze the market from a standpoint of volatility, the market goes through cycles known as regime change. Periods of high volatility or large price swings are followed by periods of low volatility and steadily rising prices. The market spends about 85 percent of the time in low volatility with rising prices and only about 15 percent in periods of high volatility with falling prices or large price swings.Investors should be prepared for the possibility of large price swings. What you do depends on your age, income, portfolio and individual risk tolerance. A young person should generally look at market declines as a buying opportunity and use a dollar cost averaging approach. Market volatility actually benefits the person who is dollar cost averaging because they are likely to be investing at market low points.The situation for the last few years has been difficult for retirees; record low interest rates have led people into riskier investments seeking income. Some investors may want to consider some form of a hedge. A hedge is like portfolio insurance. You can use options, or inverse or leveraged ETFs to offset downside price movement. Investors have to be very careful using inverse and leveraged ETFs and options.Kenneth Roberts is a Truckee based Registered Investment Advisor. Information on his money management service can be found at his blog at http://www.sellacalloption.com or by calling 775-657-8065. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.