There’s nothing like higher stock prices to cure investor blues. According to the American Association of Individual Investors (AAII), bullish sentiment increased by 5.1 percentage points this week from 35.82 to 40.93, which is the highest level since the end of August. Over the last two weeks, bullish sentiment has increased by 12.1 percentage, which is the largest two-week increase since January 5th. Based on the last two weeks, it appears as though investors are more optimistic that lawmakers in Washington will come to an agreement over the fiscal cliff.
After $2B in spending and plenty of grousing about gridlock in Washington, the American public voted not to change the balance of power. This has agitated investors who have turned their attention from the election to the impact of going over the “fiscal cliff”. The possibility of more brinkmanship like we saw last year over the debt ceiling debate has many worried about the future of the markets and indeed the country. And with good reason. It’s hard to imagine how the very leaders who got us into this mess have any inkling of how to get us out.
Still, it is important to separate politics from the investment markets. After all, the markets have climbed steadily over the past twelve months. Both stock and bond markets have been “risk on” despite all the worries of our country’s mounting debt, European solvency, high unemployment and a slowing economy. Since the S&P 500’s peak on September 14, the index has given up 7.6%. But the index is still up nearly 8% for 2012.
It may tempting for some investors to pull back on their stock exposure, but do so at your own peril. If Washington were to announce even a temporary fix to the fiscal cliff, it could result in a substantial relief rally. A “Grand Bargain” could lead to a more sustainable rally. With an estimated $3 trillion of cash on corporate balance sheets, this type of agreement could be the catalyst for CEO’s to unleash some of this cash in the form of new hiring and capital expenditures that spurs the next market rally.
In the meantime, a disciplined investment approach is the order of the day. Between now and January 1 expect to see more agitation of the markets. Congress has backed themselves into a corner. They need to find some common ground on these problems or we may suffer severe consequenses for both the country and the investment markets.