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12/11/2012|  David Joy

It should come as no surprise that the best seller at the bookstore on the south rim of the Grand Canyon is entitled, "Over the Edge: Death in the Grand Canyon." It is full of tragic, but mostly avoidable, instances of injury and death by visitors oblivious to the danger of the imposing landscape. I was reminded of this when thinking about the fiscal cliff. The dangers seem obvious to many, but apparently less so to those closest to the edge in Washington. The solutions also seem obvious, but less so to those who insist on maintaining party lines. Let's hope that rational thinking dominates the negotiations from this point, and that everyone takes a step back from the edge. As with the Grand Canyon accidents, this is a tragedy that is avoidable.

It is no surprise that the fiscal cliff dominates investor attention and markets are stuck until there is some movement in the negotiations. Investors expect a deal. But, the chance of no deal is too high to have an aggressive over-weighted risk position. The most recent talking points out of Washington hint at a possible deal that both raises tax rates and adjusts entitlements. If we get it, stocks could rally sharply as investors breathe a sigh of relief.

If the fiscal cliff is triggered, a short-term flight to safety will likely follow, with stocks falling and treasuries rallying. However, any economic slowdown should be a relatively short cyclical downturn. In the long run, what is more important than the fiscal cliff are the details of any grand bargain. Especially important will be any changes that would adversely affect the recovery in housing, an important source of strength in an otherwise uneven recovery.

Let's twist again

In 1960, Chubby Checker soared to number one on the charts with his song "The Twist." Not one to let go of a good thing too early, he followed that up with another single entitled "Let's Twist Again," which rose to number 8 and won a Grammy Award. Which brings us to the other big event in Washington this week. The Fed meets on Tuesday and Wednesday, and with "Operation Twist" expiring, the question is what, if anything, will replace it? Like Chubby Checker, and believing in its success, the Fed will most likely be inclined to follow Operation Twist with something similar. Look for a program of similar size-$45 billion a month-that involves more money printing, which will be even more stimulative. Like QE3, it will likely be open-ended. You can be certain that the Fed is rooting hard for some help from the fiscal side of things and is watching the fiscal cliff negotiations closely.

The question is whether the Fed will overplay its hand. Mr. Checker went on the record "Twistin' USA", "Slow Twistin'", "Twistin' Round the World", and "Twist It Up" and met with decent, but diminishing success.

Two steps forward...

There has been some good news on the economy lately. Vehicle sales, ISM non-manufacturing, unit labor costs, November jobs, and housing activity have shown improvement. But, there is no doubt that the policy uncertainty is taking its toll on capital spending and consumer confidence.

The economic news out of China continues to be mostly encouraging, although not without question marks. Both industrial production and retail sales rose smartly in November. These reports follow the improvement in manufacturing reported last week. After hitting a four year low on December 3 the Shanghai Composite index is higher by 6 percent. However, China also reported that its export growth in November slowed to a disappointing rate of 2.9 percent, down sharply from the October pace of 11.6 and 9.9 percent in September, raising the possibility that the recent production improvement may be mostly attributable to seasonal holiday demand and not indicative of real cyclical improvement.

Nightmare on the Via Veneto

In Europe, the news that Prime Minister Monti will resign is not being well received. The yield on ten-year Italian bonds has risen 32 basis points in Monday trading. Spanish yields have risen by 17 basis points. And Italian stocks are lower by 3.5 percent. The prospect of a return to power by Silvio Berlusconi is being greeted with the same enthusiasm as the reappearance of Freddie Krueger in the Elm St. neighborhood.

Important Disclosures:

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

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