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Health & Fitness

David Joy: Markets embrace fiscal cliff deal, but more drama ahead

David Joy examines the early market reaction to lawmakers' deal to avert the fiscal cliff.

Now that a deal to avert the fiscal cliff has been reached, the question is whether it is a good deal. The answer likely depends on one's perspective. And for most, there is more than one perspective.

First, we can all breathe a sigh of relief that the country is not unnecessarily lurching into recession. Clearly, investors around the world feel the same way, as evidenced by the overnight gains in Asian markets and the strong opening in Europe on Wednesday. The same sentiment can be seen in sovereign debt markets, as yields in safe haven countries are spiking higher, while in trouble spots they are moving sharply lower. The dollar is falling and commodity prices are rising.

As taxpayers, most are generally feeling good this morning. Unlike the rhetoric of the campaign trail, the line separating the middle-class from the rich was drawn, for the most part, at $450,000 of income, for a couple filing jointly, rather than $250,000. The long-term capital gains rate was set higher at 20%, but so was the rate on dividend income, avoiding a possible increase to ordinary income rates. So, for those at the upper end of the income spectrum the prevailing sentiment is that although taxes are going up, it could have been a lot worse.

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The problem with the deal for patriotic citizens and long-term investors is that it does little to address the deficit. And after all, that was the whole point of the fiscal cliff mechanism. Not that such a blunt instrument was ever the best way to address the problem, but the sequestration did force Congress to confront it. With this deal, Washington has divided the issue, but not conquered it. It has chosen to address primarily the revenue side of the equation, but not the spending side. The Congressional Budget Office has projected that, compared to the fiscal cliff, this deal will add $4 trillion to the national debt over the next ten years.  

From the narrow perspective of revenue alone, House Republicans can take some satisfaction. Although they were unsuccessful in structuring a deal that generated higher tax revenue by maintaining current rates and limiting deductions, the total amount to be raised is less than what Speaker Boehner had proposed in his negotiations with the White House. But if the objective of the Republican caucus was, and remains, deficit reduction, this deal falls well short and the job remains unfinished.

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Which brings us to the question of what happens when the next deadline approaches? The spending issue has only been postponed, not resolved. The sequestered cuts have been pushed out by just two months, setting up another confrontation in just a few short weeks, with the fast-approaching need to raise the debt ceiling acting as a point of leverage. And we all remember how well that went the last time Congress chose to couple the deficit issue with the debt ceiling. That's what got us here in the first place. President Obama has said he will not negotiate on the debt ceiling. He also said any future spending cuts will have to be accompanied by additional tax increases. The rating agencies are watching carefully.

As flawed as this deal is, let's be thankful that we are not plunging over the cliff. If crisis management is how the political class must deal with big issues, so be it. But this deal will only prove to have been worth the effort if it represents just the first step in an ongoing process to enact lasting fiscal reform. For now, recession will be avoided. Risk assets will rally, at least temporarily. But, we should not believe for a moment that with this deal a lasting peace has been achieved.

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The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

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