US ‘fiscal cliff’ challenge postponed, not resolved, say investors

World equity markets saw in the New Year with an exuberant bounce on the back of an 11th-hour agreement between the major US political parties to both raise taxes and cut social benefits, but already investors are questioning whether the deal is enough.

US markets reacted positively, with the S&P 500 posting its best last day gain since 1974, and helping the US to a 13% gain for the year. But even that lagged the 20%+ returns of Germany, Japan and Hong Kong, and some analysts said the rise owed much to short covering rather than “real activity”.

Didier Saint Georges (pictured), a member of the Investment Committee at Paris-based Carmignac Gestion said Republican and Democrat representatives “have been wise enough to avoid the worst”. “Republicans blinked first, as was to be expected following the result of the Presidential elections. It is therefore fair to witness a relief rally in the markets.”

Mouhammed Choukeir, CIO at Kleinwort Benson, said reading beyond the congratulatory headlines is “depressing”. Of the three key issues – tax increases, spending cuts and the debt ceiling – policymakers have tackled just one: tax increases, he said.

Tom Becket, CIO Psigma Investment Management said the final 89 to 8 vote to pass the measures “hid a lot of pain”. “We would argue the damage had already been done and the pathetic and irresponsible horse-trading over the agreement once again showed US politicians in a very bad light…”

The biggest surprise about the deal was the strength of Republican support, despite previous pledges by many to never vote for a tax increase, according to Dan Morris, global strategist at J.P. Morgan Asset Management. “This bodes well for the upcoming debate about spending cuts, the other half of the fiscal equation.”

But Richard Lewis, head of Global Equities at Fidelity Worldwide Investment said the compromise was “deeply unimpressive”. “The issues of the debt ceiling and spending cuts have been left for another day, actually just a few weeks away, when all this partisanship will make headlines once again.” He expects little relief from the “Washington shenanigans” unless there is serious weakness in the dollar.

The drama managed to eclipse temporarily Europe’s ongoing debt crisis, and avoided technically tipping the US back into recession, with adverse consequences for other markets. Many analysts were always confident that a deal would eventually be done, despite the grandstanding.

Mike Turner, head of Global Strategy and Asset Allocation at Aberdeen Asset Management said the longer term question is still about levels of government spending. “The US deficit remains too high…Until a long term plan is agreed which reduces the annual budget deficit to less than 3% of GDP, investors are likely to remain nervous.”

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