‘Fiscal cliff’: Will Wall Street light a fire under Congress?

When it comes to the “fiscal cliff,” Wall Street has yet to hit the panic button – although some politicians might wish it would.

Rep. Peter Welch, a Democrat from Vermont, practically begged for a sharp sell-off on Wall Street to get Congress to make a deal.

“If we get pistol-whipped by the market, if it punishes us for our failure to act, it might be the only thing that gets us to act,” he told CNBC.

It wouldn’t be the first time a sell-off on Wall Street prompted Congress to do something. Back in October 2008, an initial failure by Congress to help the banking industry caused the Dow Jones Industrial Average to fall 30 percent, or about 3,000 points, in two weeks.

That hasn’t happened so far this time. Yes, in the past four trading sessions, the market has declined modestly. But since President Obama’s reelection, the Dow is off only about 130 points, or about 1 percent.

On Thursday, the Dow had a roller-coaster day, at one point falling nearly 140 points before recouping most of its losses when reports circulated the House would return on Sunday. At 4 p.m., the average was down only about 19 points.

What’s going on?

Wall Street’s shrug is partly related to its feeling that no matter what happens over the next few days, Congress will still come through early in the new year.

“It makes no difference whether it’s next week or on Jan. 4, when there is a new House of Representatives,” says David Kotok, chief investment officer at Cumberland Advisors in Vineland, N.J. “They will reach a deal because they have to reach a deal.”

Pete Davis of Davis Capital Investment Ideas, who advises many Wall Street clients about Congress’s actions, says many of his clients think as Mr. Kotok does – that Congress will act early in 2013.

However, “I keep telling them that is not my view,” he says. “They will reach agreement, but not before a fair amount of damage.”

Still, some on Wall Street think Congress doesn’t have to act right away.

“It’s not like we’re going to be plunging off the top of Niagara Falls and into the river in one day,” explains Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore. “If there is no agreement in six or eight weeks, then you will see some serious consequences.”

With no deal, the expectation on Wall Street is that the economy will enter the new year at a very slow pace. In the first quarter of 2013, the economy will be growing at a 0.6 percent annual rate, estimates Sam Bullard, a senior economist at Wells Fargo Securities in Charlotte, N.C. That is barely above stall speed.

“If they don’t do anything, that could make the economy stumble and the chances for a recession increase,” Mr. Bullard says. “What Congress does will be the key determinant of the trajectory of growth for 2013.”

Already, Bullard says, businesses have started to slow hiring and spending on capital projects. “If there is some certainty about tax policy and health-care costs, business will be in a better position to decide if it should hire people and if capital spending makes sense,” he says. “That comfort level is not there yet.”

The stock market would be cheered, he says, if Congress does some kind of short-term deal early in the year and then works on some kind of “grand bargain” over taxes later on.

On Thursday, there was some indication that the concern of businesses may be spreading to Main Street. The Conference Board’s Consumer Confidence Index fell fairly sharply in December compared with November. Most of the drop was in consumers’ expectations for the future, which fell to their lowest level in a year.

“The drop in the expectations index was likely due to concerns about the fiscal cliff,” wrote Dean Maki, an economist at Barclays Research, in an analysis. He says consumers’ concerns indicate “they recognize that they face a large potential drop in income if no agreement on the fiscal cliff is reached soon.”

In a sign that consumers might have started to worry about the fiscal cliff this month, retail analysts have started to reduce their estimates of holiday sales. “It looks like holiday sales were only up about 0.7 percent, while most people had been looking for growth of 3 percent to 4 percent over last year,” Mr. Dickson says.

Dickson worries that a slow holiday season, combined with a business slowdown in spending, could cause the stock market to start 2013 with a thud.

“We would not be surprised to see the market down 3 percent to 5 percent,” he says. “We would encourage our investors to view that as a buying opportunity.”

A drop of 5 percent translates into a fall of about 650 points on the Dow – a drop similar to what Representative Welch says might get Congress to act.