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Going off 'cliff' with a bungee cord

After staying flat through September 2011, the S&P 500 jumped 31 per cent between October and the end of March

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The 1987 crash. The Y2K bug. The debt ceiling debacle of 2011.

All these events, in the end, turned out to be buying opportunities for stocks. So will the ‘fiscal cliff,’ some investors say as they watch favorite stocks tumble during the political give-and-take happening in Washington.

The first round of talks aimed at avoiding the ‘fiscal cliff’ caused a temporary rise in equities yesterday, signaling Wall Street’s recent declines could be a buying opportunity. The gains were small and sentiment remains weak, but it suggests hope for market bulls.

Though shares ended moderately higher yesterday, it was not enough to offset losses for the week. The S&P was down 1.5 per cent, while both the Dow and the Nasdaq fell 1.8 per cent.

The S&P 500 is down more than five per cent in the seven sessions that followed President Barack Obama’s re-election. Uncertainty arose as attention turned to Washington’s task of dealing with mandated tax hikes and spending cuts that could take the US economy back into recession.

Some see the market’s move as an overreaction to hyperbolic headlines about policy gridlock in Washington, believing stocks may start to rebound in what should be a quiet few days ahead of the Thanksgiving holiday next Thursday.

“It just doesn’t seem to make any sense that you suddenly wake up the day after the election and realise we’ve got a fiscal cliff,” said Krishna Kumar, partner at New York hedge fund Goose Hollow Alpha Advisors.

Not long ago the S&P was on target for its second-best year in the last 10, riding a 17 per cent advance in 2012. That’s been halved to about eight per cent, which isn't bad but disappointing compared with just a month ago.

Investors have been selling the year’s winners. Apple is down 25 per cent from its peak above $700. General Electric is down 14 per cent; has lost 16 per cent. Overall, the stocks that make up the top 10 per cent of performers in the month prior to Election Day have been the worst performers since, according to Bespoke Investment Group of Harrison, New York.

“I think it’s a good opportunity to be long stocks at these levels,” said Kumar.

Hikes on capital gains and dividend taxes are on the line, and Obama has dug in his heels on what he sees as a mandate to make the tax code more progressive.

He seems to have the upper hand in dealings with Congress because Republican lawmakers don’t want to see tax rates increase, which is what will happen if no solution is found by the beginning of 2013. Republicans don't want to take the blame for driving the economy over the cliff.

The current crisis is similar to last year's fight to raise the US debt ceiling, which led to the downgrade of the United States’ top credit rating in early August 2011.

During the dealings, the S&P 500 lost 18.8 per cent between its peak in July 2011 and its bottom in August. As the market slid, the political standoff badly hurt investors’ confidence in Washington, setting off a spike in volatility.

In the end a deal was announced that raised the ceiling and put off longer-term fiscal decisions until January 1, 2013, setting the stage for today’s ‘fiscal cliff’ crisis.

After staying flat through September 2011, the S&P 500 jumped 31 per cent between its October low and the end of March.

Buy the dip? Gridlock in Washington and all that could possibly go wrong with the economy if a deal is not reached have grabbed the headlines, but the negotiations leave room for stock market gains. Congressional leaders said yesterday they will work through the Thanksgiving holiday recess to find a solution.

“The debate over how to solve (the fiscal cliff) may be more productive than is commonly recognised,” said Brad Lipsig, senior portfolio manager at UBS Financial Services in New York.

“The US is facing a major debt overhang, and serious steps toward addressing it might ultimately be viewed as a positive for future growth,” he said. “The market may recognise this and, after a time of hand wringing, recover from the concerns with a renewed sense of optimism.”

The recent selling took the S&P 500’s relative strength index - a technical measure of internal strength - below 30 this week, indicating the benchmark is oversold and due for a rebound.

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