Volatility is the name of this game. With the S&P 500 above 1,400 following five days of gains, traders will be hard- pressed not to cash in on the advance at the first sign of trouble during negotiations over tax hikes and spending cuts that resume next week in Washington.
President Barack Obama and US congressional leaders are expected to discuss ways to reduce the budget deficit and avoid the ‘fiscal cliff’ of automatic tax increases and spending cuts in 2013 that could tip the economy into recession.
As politicians make their case, markets could react with wild swings.
The CBOE Volatility Index, known as the VIX, Wall Street’s favorite barometer of market anxiety that usually moves in an inverse relationship with the S&P 500, is in a long-term decline, with its 200-day moving average at its lowest in five years. The VIX could spike if dealings in Washington begin to stall.
“If the fiscal cliff happens, a lot of major assets will be down on a short-term basis because of the fear factor and the chaos factor,” said Yu-Dee Chang, chief trader and sole principal of ACE Investments in Virginia.
“So, whatever you are in, you’re going to lose some money unless you go long the VIX and short the market. The ‘upside risk’ there is some kind of grand bargain and then the market goes crazy.”
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He set the chances of the economy going over the cliff at only about five per cent.
Many in the market agree there will be some sort of agreement that will fuel a rally but the road there will be full of political landmines, as Democrats and Republicans dig in on positions defended during the recent election.
Liberals want tax increases on the wealthiest Americans, while protecting progressive advances in healthcare, while conservatives make a case for deep cuts in programmes for the poor and a widening of the tax base to raise revenues without lifting tax rates.
“Both parties will raise the stakes and the pressure on the opposing side, so the market is going to feel much more concerned,” said Tim Leach, chief investment officer of US Bank Wealth Management in San Francisco.
“The administration feels really confident at this point, or a little more than the Republican side of Congress may feel,” he said. “But it’s still a balanced-power Congress, so neither side can feel that they can act with impunity.”
Tension in West Asia and unresolved talks in Europe over aid for Greece could add to the uncertainty and volatility on Wall Street could surge, analysts say.
An Egypt-brokered ceasefire between Israel and Hamas came into force late on Wednesday after a week of conflict, but was broken with the shooting of a Palestinian man by Israeli soldiers, according to Palestine’s foreign minister.