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Don't Trade the Fiscal Cliff Headlines

U.S. News Staff

Recently the Financial Times printed in different sections on the same day two headlines concerning the impending U.S. fiscal cliff. One reported rising hopes for a successful conclusion to the budget negotiations and described a resulting market rally. The other, a few pages earlier, told us that negotiations risked failure, with troubling implications for financial markets. And the news is supposed to guide our investing?

If you spend your day as I do staring at financial screens or business television, you've gotten used to market reactions and over-reactions to economic data releases, company earnings reports, and central bank policy pronouncements. To some extent, these reactions do reflect markets' natural attempts to price new information--faster growth, higher inflation, better sales, lower interest rates and the like--that can change today's value of future cash flows, and the trajectory of future asset prices.

But even though economic and financial developments can affect the value of investments, I always caution investors against materially changing their investment posture even though markets may spike up or down when surprising reports cross the wire. Those reports get revised, they're filled with random noise, and markets will adjust to them more quickly than we can. Our time is better spent trying to figure out how changing patterns of data reveal changing economic and financial trends, and is wasted trying to react to each blip on the charts.

If most traders and strategists are honest, they'll admit to getting burned trying to outsmart the tape. But look what's going on now: we're all trying to be political scientists and buy and sell with the headlines tracking the tortuous path of negotiations over the infamous fiscal cliff in the near term and the eventual path of U.S. federal finances over the longer haul.

The president shakes hands with a GOP leader and the market rallies. One side or the other stakes out a newly aggressive policy stand on taxes, spending or both, and the market sells off. Keep in mind, though, where those headlines are coming from, and who their intended audience may be. They are not just journalistic reports on the state of an evolving story; they are an integral part of the negotiation process. Like boxers who attack and feint trying to gain an advantage, politicians mix confrontation with conciliation, knowing there won't be a KO but hoping their side will ultimately win on points. Getting the press to report some, but not all, of their negotiating positions is a tried and true political tactic, a compliment to the highly technical financial modeling and the face-to-face give and take that occur behind closed doors around the capital. Contradictory headlines are just one obvious result.

Political headlines, especially when the stakes are as high as they are now, are likely to be even more random and volatile than their economic counterparts. Consequently, attempts to trade in financial markets on the basis of political news carry a low probability of success.

That doesn't mean we should ignore the current budget debate. We'd all be well advised to consider adjusting our financial plans to prepare for the likelihood of higher taxes for many of us and lower government spending on some programs we currently take for granted. If policy makers do succeed in reducing government deficits, we will all feel the effects. In particular many of us could face funding more of the healthcare we want, cushioning the costs of crop failures and coastal flooding, or financing our housing and higher education to name just a few of the valued items federal subsidies and tax preferences now support. Bearing those increasing costs will keep many of us working longer and harder and encourage us to invest more strategically.

Making legislation is a lot like making sausage, whether or not Otto von Bismarck, the Iron Chancellor, ever actually made that comparison. Even if Bismarck had suggested averting one's gaze from the process of legislation, he would have been speaking to the subjects of a king, not the citizens of a democracy. As citizens we should watch the legislative process and hold our elected officials accountable if the sausage stinks, but we shouldn't allow their sparring to knock our investment plans out of the ring.

Jerry Webman is the author of MoneyShift: How to Prosper from What You Can't Control and Chief Economist at OppenheimerFunds.