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Stocks Appear Poised to Gain After Fiscal Cliff Deal

The Exchange

(Updated at 11:31 p.m. ET, Jan. 1, 2013)

If the U.S. market follows the pattern that's so far building overseas, stocks look set to start the new trading year with gains.

With the Republican-led House of Representatives joining the Senate in approving a measure to avoid the tax hikes and spending reductions known as the fiscal cliff, Wall Street seems poised to welcome the news and send stocks higher, at least at the outset of the first session of 2013.

Traders at the New York Stock Exchange: Credit Reuters

The Senate reached an agreement to avert the cliff hours prior, but the House wasn't ready to sign off. As late as Tuesday evening, it appeared that an accord might not pass both chambers of Congress before the market opened Wednesday. However, once GOP House members gave up on a wish to get new government spending cuts by way of the pact , it was only a matter of time before the deal was done and headed for President Obama's desk.

For investors, getting past the cliff isn't a guarantee that the American market will advance, but should it track foreign exchanges that are currently open and cheering the settlement, an early climb is in the cards. Being left in limbo may have been the worst possible outcome, and if no progress had been made before New York's market got under way, traders may have opted to deliver Washington a loud message about intransigence by punishing stocks.

Multiple Markets Rise

After it became clear the U.S. fiscal chaos was contained, Australia's All Ordinaries (^AORD) index was up 1.3%, and South Korea's Kospi (^KS11) was gaining 1.5%. The Taiex in Taiwan was better by 1.1%, as was the Singapore Straits Times Index (^STI). Hong Kong's Hang Seng (^HSI) was the strongest of the Asia-Pacific averages, rising 1.8%. Tokyo was closed for a holiday.

Generally speaking, the deal should be good for the domestic market since it eliminates an immediate worry. Of course, also generally speaking, the fiscal cliff will prove to be only one point on the continuum of uncertainty, and soon it will be replaced by something else. The top candidate for inducing angst in the markets next is whether to raise the debt ceiling, around which the upcoming debate undoubtedly will be contentious. As a reminder, the 2011 dispute over the ceiling was one of the factors in Standard & Poor's decision to downgrade the U.S. credit rating from AAA.

The longer lawmakers went without finalizing a fiscal cliff package, the worse it could have gotten for the nation's finances. Were the full cliff to have been realized, many market and economic observers were expecting gross domestic product to suffer mightily, and a number predicted a recession was all but certain. [Get the details on what Congress forged from Olivier Knox at Yahoo! News: House Passes Fiscal Cliff Deal, Tamps Down GOP Revolt.]

Danny Riley, a Chicago-based futures trader and president of MrTopStep.com, noted that from his view, the market already had a positive that could surface here and support stocks. Traders initiated a number of short positions last Friday, and much of the buying on New Year's Eve, when stocks finished the last year with significant gains, was short-covering to close those positions, he says.

"We think it’s safe to assume that not all the shorts have covered yet," he says in an email, adding that he believes the first few days of January will be upbeat for equities, aided by low trading volume. As traders move to close out shorts, that demand can have the effect of driving up stock prices. Even so, "we do not think we will see a repeat of last year when the markets went straight up in the first quarter."

Riley's watching 1433, 1450 and then 1485 as key technical levels in the S&P futures, that is, areas where traders will battle over whether to keep bidding up stocks or decide to start selling. The S&P index ended 2012 at 1426.19.

"Can they sell the news tomorrow?" he says. "Sure, but the buyers will be out in force."

What Comes Next

No one can predict the future, but owing to the extensive, months-long build-up to the fiscal cliff, it's easy to see how traders would be relieved, if only for a few hours, to have it done with. Let's look at the possibilities for what could happen with the market tomorrow:

  • An immediate rally in U.S. stocks carries through the day, which again, for the time being, appears entirely plausible. Just remember that as soon as the cliff celebration is out of the way, the markets will be worried about something else, so Thursday may be another story. Again, the debt ceiling is a strong contender to fill this role.
  • Stocks start with an advance, but that fades and the major markets are negative by day's end. Professional traders and trading programs aren't necessarily going to let any early profits run all session. They get spooked, they get out. They don't operate the way the home investors do, any more than the New York Yankees operate like your Saturday afternoon softball team. Never, ever forget that. Buy and sell points are often driven by technical indicators, not something as clear as getting a fiscal cliff deal.
  • From the outset, selling prevails and persists. This would be a surprise based on the behavior of global markets late Tuesday night, U.S. time. That said, equity markets still could open down based on the idea of selling into a known event. One of the many adages about Wall Street is the concept of "buy the rumor, sell the news." Stocks were up big on Monday helped by anticipation of an agreement -- the Dow Jones Industrial Average (^DJI) climbed 166 points, or 1.3%, the Nasdaq (^IXIC) rose 59 points, or 2%, and the S&P 500 (^GSPC) was up 24 points, or 1.7%, to end a fourth straight positive year on a high note.
  • Selling of stocks starts early and reverses as programmed buy levels are hit and pros see prices they like. The day ends higher. As stated before, a weak open would be unexpected as it stands currently, but with trading, you never know.

Now, if you're average Joe or Jane investor planning for retirement or the long term, your big picture hasn't been repainted substantially. You still want to see whatever assets you own, whether they're stocks, bonds, commodities or anything else, improve your financial situation over time. You may indeed see changes in various tax rates that do affect aspects of how you invest, but it's unlikely that your financial adviser will tell you to buy with both hands or to sell everything and head for the hills. In other words, you'll hear a lecture that you're thinking years into the future.

Certainly not everyone will be happy with the fiscal cliff compromise, but history has shown that investors do learn to adapt to the circumstances they're given, even when they're unfavorable. The ultimate take-your-ball-and-go-home alternative of hoarding cash under the mattress hasn't ever proven popular on a massive scale. The near term, though, can be stomach-churning as new rules are ingested and become familiar.

The direction of the U.S. should become clearer once Europe's major markets open overnight. In particular, the FTSE 100 (^FTSE) in London, the DAX (^GDAXI) in Frankfurt and the CAC 40 (^FCHI) in Paris will be good indicators. Markets are interconnected, and while they don't always move in lockstep, we can get further valuable clues about what will happen on the western side of the Atlantic a few hours from now.