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How the "fiscal cliff" is affecting stocks

(MoneyWatch) The daily financial news is fixated on the "fiscal cliff." One recent headline read, "Stock futures rise on fiscal cliff optimism," while another said, "Stocks down as fiscal cliff scares investors."

Is the stock market really reacting to the fiscal cliff, or are the daily market fluctuations merely random movements that the media mistakenly interprets as driven by the package of government spending cuts and expiring tax breaks scheduled to take effect in January?

To better answer the question, let's take a step back. As we entered November, we were 61 days away from the fiscal cliff, with the hopes that the presidential election would open the door to political leaders reaching agreement on tax and spending policies. Now we have used up 40 of those 61 days, and the only two things both parties can agree upon are the catastrophic long-term impact of falling off the cliff and that we remain far from an agreement.

With the clock ticking and progress seemingly slow, it would be reasonable to assume the stock market might signal its concerns by registering significant decline. Yet the market demonstrates, as it often does, that its movements are not all that reasonable and at times even unfathomable.

For instance, between October 31 and December 7, the U.S. stock market is actually up 1 percent, as measured by the Vanguard Total Stock ETF (VTI). International stocks are up 3.2 percent, as measured by the Vanguard Total International Stock ETF (VXUS). And year to date, both U.S. and international stocks are easily up double digits.

I've long been an advocate of refraining from reacting to the news and sticking to an asset allocation, but let me confess something. If I had known on October 31 that Congress would still not be making progress, I probably would have significantly reduced my exposure to stocks, as my guess would have been that stocks would be down 10 percentage points in the wake of this dismal news.  Luckily, I lack a crystal ball.

Though one could argue that the stock market is irrational or that other positive events offset the fiscal cliff talks, the reality is that for the past 40 days, the expert opinion on the fiscal cliff's impact on stocks has been grossly overstated.

The truth is that we don't know how the stock market will perform over the next three weeks -- irrespective of how the talks go -- nor can we even be certain they will decline in early January if we sail off the cliff. (Personally, in case anybody in Washington is reading this, I don't particularly want to find out how stocks will perform on the other side of the fiscal cliff).

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