Just caught a news flash that the Republicans are insisting that any overnight "fiscal cliff" deal include changing the calculation---switching to the "Chained Consumer Price Index"--- for social security cost of living increases. Which would result in lower annual adjustments for inflation. This is being billed as a "major setback". Although I recall, just a week or so ago, that the President was amenable to the idea.
If "major setback" in this eleventh hour means we fall off the "cliff", expect a messy stock market for the next few days. Then, very early in the new year, expect the politicians to quickly claw their way back up the cliff with an agreement to keep the Bush-era tax rates alive for folks earning less than $250,000 (or $400,000 per the President's last unofficial offer). The debate over spending cuts, however, is likely to persist right up to the hour Tim Geithner says he can no longer pay the nation's bills. As it stands we hit the debt ceiling limit tomorrow, which gets him juggling the books, which he says he can do for a couple of months. It'll be interesting to see if the Republicans have the political will this time around to stand their ground on spending cuts, as they did during last year's debt-ceiling debate.
There's a potential political benefit for the Republicans by not dealing on taxes until after Tuesday. That way we fall off the cliff, tax rates on every taxpaying American go up, then they can turn around and strike a tax reduction deal. In essence, they can claim credit for cutting tax rates for the middle class, and not raising taxes on upper-income earners (that'll have already happened by itself) if they wait just 48 hours---as opposed to dealing now and getting blamed for agreeing to a tax hike on upper-income earners.
I maintain that the Democrats are in the driver's seat either way. A deal gets done before Tuesday and they take credit for preserving the tax rates on the middle class. No deal now means they take credit for lowering tax rates on the middle class next week.
The political dynamic is that higher taxes on upper-income earners will be viewed as a defeat for the Republicans and a victory for the Democrats. But make no mistake, whether it occurs today or this coming Friday (or some time shortly thereafter), taxpayers earning some number above some number are going to see their tax rates higher than they are today. The deciding factor, in terms of timing, is all about the political ramifications.
Back to the market: As I suggested above, no deal tonight should be greeted none too warmly by traders tomorrow. A deal in January, however, could easily nullify tomorrow's action. In either event, the "fiscal cliff", by itself, is not an event that should in anyway alter your longer-term investment strategy...
I'll keep you posted...