If you've been hoping for the chance to buy stocks at a bargain, pray for a full-speed plunge off the fiscal cliff.
Since President Obama's re-election, stocks have fallen by about 5 percent—and not because investors necessarily dislike Obama. The election removed one big uncertainty: who will govern the country for the next four years. But it amplified another, because a government divided between Democrats and Republicans will now have to resolve the biggest set of economic decisions Washington has faced in years. Stocks could swing 10 percent or even 20 percent in either direction, depending on the outcome.
Those decisions, of course, represent the "fiscal cliff" that the U.S. economy will tumble over if Congress botches them. Beginning in 2013, about $535 billion of annual tax hikes and $110 billion in government spending cuts are due to go into effect, if Congress does nothing to stop them. If all those measures take effect, it could slash GDP by 4 percent, easily triggering a recession.
If Washington politicians are able to work out a compromise solution that reduces the national debt over time while forestalling an immediate downturn, many economists think 2013 could be a prosperous year, with a pickup in spending and considerably more hiring. The catch, needless to say, is that the current batch of politicians in Washington has demonstrated a preference for combat over compromise, no matter what the consequences for the economy.
That's why many investors are gloomy about the next several months. David Chalupnik of Nuveen Asset Management, for instance, told Yahoo! Finance recently that the market could drop another 10 percent as the fiscal-cliff deadline of December 31 approaches.
Investors aren't just worried about a possible recession, but also about new taxes on dividends and other types of investment income that could depress demand for equities. "Investors are tripping over themselves in an attempt to lighten their positions in stocks," Sam Stovall, chief equity strategist for S&P Capital IQ, explained to clients recently.
Yet many of the analysts worried about an imminent stock-market correction are also bullish about the next couple of years. S&P, for instance, expects the S&P 500 stock index to reach 1,500 within 12 months, which would be an 11 percent gain from where it is now. If stocks fall further as the cliff deadline approaches, the potential for profits would be even greater. "This swift exodus [from stocks] may soon be followed by a 'V' shaped recovery should a resolution be forthcoming," Stovall says.
That could represent a great buying opportunity for investors able to wait for the fiscal-cliff drama to subside. Stock trading is notoriously short-sighted these days, with buying and selling dominated by huge institutional traders relying on computers to spot opportunities for marginal short-term gains. Far fewer investors buy for the longer term. So a "macro play," as traders call it—betting on an overall improvement in economic fundamentals over months or years—could be a counterintuitive way to take advantage of a short-term selloff.
Needless to say, there are risks. A political standoff that goes on longer than expected could damage the economy in ways that can't be repaired quickly. The cliff negotiations could drag on for months, casting an indefinite pall over the economy. Investors could finally lose confidence in the U.S. government, forcing up its borrowing costs and making the cliff problem a lot worse. To all that, add chronic worries about a European debt meltdown, an Iranian military confrontation, and a bigger-than-expected slowdown in China.
But there are always risks, especially these days. Less frequent are opportunities to buy stocks at a discount. If you have faith in Washington's ability to solve problems, after exhausting all other options, such a moment may be fast approaching.
Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.