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The United States may or may not go over the fiscal cliff in January, but few investors are taking the possibility seriously enough.
That's the message Goldman Sachs (NYSE: GS) chief U.S. equity strategist David Kostin had for his clients in a recent note.
He believes investors are not focusing enough on the potential impact of the fiscal cliff, which could set the stage for jittery markets akin to last year when the debt ceiling debates sent stocks tumbling.
When it comes to anticipating the impact the fiscal cliff will have on markets, "portfolio managers have been swayed by hope over experience," Kostin recently said in his note.
Kostin compared the current situation to last year's debt ceiling crisis when Congress waited until the eleventh hour to reach a deal.
"Investors were stunned and the S&P plunged 11% in 10 trading days (and more than 17% from the level one month prior to the deadline)," Kostin said. "Eventually Congress reached a compromise on raising the debt ceiling."
"We believe the uncertainty is greater this year than it was 12 months ago," Kostin said. "Political realities and last year's precedent suggest the potential that Congress fails to reach agreement in addressing the "fiscal cliff' is greater than what most market participants seem to believe based on our client conversations. In our opinion, equity investors seem unduly complacent on this issue."
The market rally enjoyed this month is a markedly different from last year's showing as markets skirted past the one-year anniversary of the debt ceiling face-offs. But Kostin says the S&P 500 is headed for a fall-and a steep one at that.
Kostin warns: "Assigning a P/E multiple to various fiscal cliff and earnings scenarios is difficult because ultimately we expect Congress will the address the situation. But investors must confront the risk they may not act until the final hour."
His year-end target for the S&P is 1,250; quite a bit lower than the current 1,424.
Dealing With the Fiscal Cliff
Republicans and Democrats remain at odds over what to do about the fiscal cliff. Most economists agree that nothing will be resolved before the November election. In fact, most expect fiscal cliff negations to linger into the first quarter of 2013.
While both parties agree the federal deficit needs to be reduced, their visions of how to accomplish are miles apart.
And the looming automatic spending cuts and the expiration of temporary tax cuts – the essence of the fiscal cliff – are creating more and more uncertainty. Business and individuals are already feeling less confident about the country's economic outlook. Scores have curtailed or eliminated expansion projects, implemented hiring freezes, and held off investing.
Commodity guru Jim Rogers is also bracing for a fall.
"The United States is the largest debtor nation in the history of the world. Our debts are skyrocketing every year and nobody's doing anything about it," Rodgers told the Fiscal Times.
"Every country in history that's gotten into this situation has had a crisis or semi-crisis, or both," Rogers continued. "In 2002 we had an economic slowdown, which was fairly serious, and then in 2007 and 2008 we had another one, which was worse because the debt was so, so much higher. The next time around the debt is going to be that much more catastrophic."
How to Prepare for Fiscal Cliff
To brace for the fiscal cliff, investors need to prepare for any possibility.
Consider booking some long-term capital gains, as that tax rate could increase from 15% to 20%.
As a hedge against the volatility the fiscal cliff will bring, investors should consider precious metals, mining stocks and related exchange-traded funds (ETFs).
Rogers thinks a commodities strategy will work no matter what happens with the fiscal cliff.
"My view is if the world economy gets better, I'm going to make money in commodities because of the shortages that are developing and getting worse," Rogers said. "And if the world economy doesn't get better, they're going to print money."
Jeff Sica of Sica Wealth Management cautions investors to pay down debt, keep their jobs and reduce non-essential spending. In other words, have a plan.
"Hope is not a good strategy," Sica told Forbes.
Don't kid yourself. If Congress and President Barack Obama can't agree on what to do, the fiscal cliff will happen. It's up to you not to get caught unprepared.
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