Fiscal Cliff Deal Averts the Crisis… But Now What?

[Editor's Note: A last-minute deal means the U.S. has avoided the fiscal cliff. Since the agreement was completed after we had gone to press, we have decided to follow up today's issue with a special edition from Keith Fitz-Gerald that breaks down the deal...]

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[Singapore] - It's late Tuesday evening and I'm about to go on air with CNBC Asia in Singapore regarding the impact of the Fiscal Cliff bill which passed minutes ago after Republican leaders decided not to try and tack on amendments nor engage in further bickering.

Passed by a 257 to 167 vote, the bill is now headed to the White House and a draft may even be on the President's desk by the time you read this.

So I'll have to write quickly.

Here's the scoop on the fiscal cliff deal:

  1. The Bush-era income tax cuts become permanent for the majority of workers while they expire for so-called "top" earners. The break is at $400,000 for individuals and $450,000 for couples. That's approximately double Obama's campaign level and 80% more than his preferred "married couples rate" according to various sources. Dividend tax rates and capital gains rates for top earners will rise to 23.8% while personal exemptions and itemized deductions that are presently in force expire for individuals earning more than $250,000 and married couples earning more than $300,000. The alternative minimum tax is now fixed to avoid snagging still more middle class households.
  2. Expanded unemployment benefits will continue.
  3. Automatic spending cuts are deferred for two months.
  4. A two percent payroll tax cut expires.
  5. Estate taxes will get an inflation indexed exemption of $5 million or more and taxes will top out at 40%.

Key takeaways on the agreement:

  1. Once again Washington is kicking the can down the road. While it's already being played up by both parties as an example of bipartisanship, it's really a load of hooey. The bill merely puts off decisions for yet another round of fiscal follies a few months from now.
  1. Instead of working diligently for the past year on a meaningful tax bill overhaul and a serious fix to entitlement programs, our leaders dithered, bickered and postured until the last minute. It's an irresponsible and disgusting abuse of the public trust. Anybody trying this kind of nonsense in the private sector would be summarily fired for cause.
  2. The deal actually raises taxes on 77% of American households according to the CBO and the non-partisan Tax Policy Center. That's an appalling failure in my book. The top 1%, incidentally, will pay $73,633 more in taxes on average. That's also according to the Tax Policy Center. It will also add another $4 trillion to deficits over the next decade. How is this a win for America?

My take on the markets:

The fiscal cliff bill passed only a few minutes ago so traders around the world are just beginning to react. However, I've already talked with key contacts in Hong Kong, Tokyo, Frankfurt and London to gauge what we might expect here at home come Wednesday morning.

I see three distinct possibilities:

First, as I suggested last week, the fiscal cliff deal is likely to prompt a short-term rally because it eliminates short-term worries. The problem is that nobody knows what short term means. Do not forget that the fiscal cliff is only one of three upcoming problems in our ongoing fiscal madness. There's still the debt ceiling, sequestration and the complete lack of a budget to contend with. In other words, it's on to the next crisis now.

Second, Asian markets are already enjoying a strong run this morning (your evening) as I write this. European futures are on the move, too. But, professional traders may see right through this and, in fact, begin selling the news leading to a down day when U.S. markets close Wednesday afternoon. The question at hand is whether or not they feel confident enough to remain "risk-on" or pick up their toys and seek safety while selling into strength.

Third, we could get a weak opening but then the pros go bargain hunting based on "oversold" conditions and a short "burn." Many traders, in fact, sold heavily into New Year 's Eve and now they've got to unwind those short positions in a hurry if Asia and Europe continue to take things higher between now when I am writing to you and early Wednesday morning when you read this.

How the fiscal cliff deal impacts individual investors:

For the most part, this will be a non-event. Yes...a non-event, especially if you are following along with a disciplined investment approach like the 50-40-10 Strategy I advocate in our sister publication, the Money Map Report.

While there is no question we will face yet more financial hurdles, I don't see any of the changes being larger than the potential gains associated with 3-5-10 year growth targets when it comes to the "glocal" stocks we prefer. So barring a massive sell off that hits our trailing stops, expect dips to remain consistent with the 10% rise I see ahead for the S&P 500 in 2013. Whether or not it finishes at that level remains to be seen but that's a story for another time particularly as we get a clearer look into the Q4 earnings season which kicks off shortly.

I envision gold having another solid year along with other commodities as it becomes clear that the market will place a premium on capital preservation as a result of yet more fiscal nonsense - deal or no deal.

And finally, I actually see the U.S. Dollar strengthening following this evening's news. It won't be immediate; if anything the dollar will drop a bit on news following the fiscal cliff deal. But down the road a bit things will be different when traders begin to focus on yet another looming downgrade and the comparative safety of the US greenback.

It's not that the fiscal cliff bill is anything even remotely resembling financially astute management, but rather that it's "business as usual."

And that means the dollar, which is the best-looking horse in the glue factory is alive and, evidently, still kicking.

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He’s a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs The Geiger Index, a reliable, emotion-free guide to making big money and avoiding losses, and Strike Force, which aims to get in, target gains, and get out clean.

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