Kick the Can
by Steven Visscher, Mawer Investment Management
Have you ever noticed what children do when they stumble upon a tin can in the middle of the sidewalk? Many will instinctively kick it. Rocks work too. So do Barbie dolls as my sister may traumatically recall. Each kick in this game is unpredictable. Sometimes the can sails straight ahead. But most kicks skip along, veering left or right, taking the players on a zig-zag course rather than a straight line. U.S. politicians seem to be playing kick the can with their fiscal challenges.
The spending cuts and tax increases that were scheduled to take effect on January 1 presented an opportunity for policymakers to boldly tackle their fiscal imbalances. But instead of sweeping changes, politicians opted to compromise on some elements of a solution, but then defer the most difficult decisions to a later date. The can was kicked.
Markets responded to this game with resounding applause. The S&P500 jumped over 2.5% on the next trading day. This was the largest single gain in over a year. The lessons from this sequence of events are twofold.
First, now that the game of kicking the can down the road has started, we may see this play out through the year. Rather than enact sweeping fiscal changes, U.S. politicians may proceed slowly, enacting modest changes in a gradual fashion. In a way, this reduces the cliff to a series of rolling hills.
Second, the market response is yet another reminder of how badly investors crave certainty. The looming fiscal cliff deadline garnered so much media attention and created so much fear that investors appear to be delighted simply to turn that page on the calendar. The fact that the āsolutionā solved little doesnāt seem to matter. We woke up the next day and had not fallen off a cliff. This behaviour may lead to more volatility in 2013, particularly if we see politicians continue to kick the can. Leading up to each subsequent deadline may create uncertainty, and each subsequent kick of the can may quell such fears.
This could make for a bumpy ride.
Steven Visscher
Copyright Ā© Mawer Investment Management
