3 more "fiscal cliffs" on the horizon

Fiscal cliff sign generic iStockphoto/CBS

(MoneyWatch) Stock markets around the world began 2013 with a huge rally, as investors breathed a sigh of relief that the "fiscal cliff" was averted at the eleventh hour. However, the measures taken to avoid the cliff were stopgaps, not solutions. There's still plenty of uncertainty out there, because there are three more "cliffs" coming up in short order.

National debt limit

Unless Congress takes action to raise the debt ceiling, which stands at $16.4 trillion, it's estimated that the U.S. Treasury will reach its credit limit sometime around the end of February. This could reprise the conflict that in 2011 brought the country within days of default and led to the first ever downgrading of the federal government's credit rating. The related financial uncertainty sowed fear among investors, and from July 1, 2011, through August 8 of that year the S&P 500 fell from 1,340 to 1,119, a drop of more than 16 percent.

A quick resolution before the latest debt-ceiling deadline looks anything but a certainty. Remember that the deal that avoided the fiscal cliff included almost no spending cuts at all. And Republicans are now insisting that they'll demand that any increase in the debt limit be tied to significant spending cuts. On the other side of the aisle, President Obama has vowed not negotiate over the borrowing limit. Meanwhile, the ratings agencies have warned that the Treasury's AAA rating is in danger if the problem isn't addressed.

Spending cuts

When Congress last week passed the bill averting the fiscal cliff, officially called the American Taxpayer Relief Act, it only addressed the revenue side of the nation's budget gap. Remember that Congress has had almost a year-and-a-half to address the spending side. In 2011, they even set up the so-called sequestration that would have imposed $109 billion in annual spending cuts, totaling $1.2 trillion, if they failed to act by December 31. About half of the reductions would have come from defense and half from non-defense programs, including education, science and technology, national parks, Medicare and other entitlements. This was set up to be so painful that lawmakers would be forced to reach a deal. Yet even the congressional "supercommittee" in 2011 failed to come up with a deficit-reduction plan. And the new law only kicks the proverbial can down the road for two months, until March 1. The prior failures and an even more ideologically divided Congress calls into question Congress' ability to agree on spending cuts within the next two months.

Congressional budget

The third "cliff" also stems from lawmakers' inability to rein in spending. For the federal government to run, Congress has to not only pass a budget, but also has to appropriate the money. When that doesn't happen, Congress has to instead pass continuing resolutions to fund the government. Right now, we're operating under a continuing resolution scheduled to expire March 27. Without another such resolution, the government could face a shutdown.

Investors are facing so many cliffs that they must feel like Wile E. Coyote. With all this uncertainty, there's certainly the potential for markets to be volatile over the next few months, putting your discipline to the test. With that in mind, there are two important considerations.

  • Even with the uncertainty surrounding this last fiscal cliff, markets rallied. Remember that if you get tempted to sell when potential deals look bleak.
  • Your investment plan should have already accounted for uncertainty in the markets. If not, get yourself a new plan.
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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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