The fiscal cliff is a term that will be a major topic of discussion in the world of investment and finance. The fiscal cliff refers to approximately $600 Billion in automatic spending cuts and tax increases in the United States that are scheduled to take effect on January 1, 2013, unless the United States Congress acts to change the law that mandates the cuts and extends tax cuts that are set to expire.
While investors usually ignore what happens in Washington, DC and focus on future earnings when considering making investments in the stock market, the potential for serious economic consequences and a possible stock market sell off in response to the fiscal cliff should not be ignored. Economists predict that if the approximately $600 Billion in automatic spending cuts and tax increases go into effect in January 2013, the United States economy will fall into a deep recession, which will likely impact corporate earnings, the stock market, and other assets in a negative way. The Congressional Budget Office is anticipating a four percent decline in United States Gross Domestic Product (GDP), while Federal Reserve is anticipating a five percent decline in GDP if the approximately 600 Billion in automatic spending cuts and tax increases take effect in January 2013. Such a significant decline in GDP will ultimately affect corporate earnings and as a result the stock market, so investors should pay attention to the pending fiscal cliff and start taking defensive actions to prepare for the possibility that the fiscal cliff occurs.
The time to prepare for the potential impacts of the fiscal cliff and protect investment assets is now. The stock market has been on a tear since it bottomed in March 2009, which has been mainly driven by United States Federal Reserve easy money policies and considerable deficit spending by the federal government to prop up the United States economy. While the easy money policies by the Federal Reserve will continue for the foreseeable future, the federal stimulus spending will be reduced dramatically after the fiscal cliff has been reached, which means the economy and stock market will have to deal with significant headwinds in 2013.
Although there is no way to predict whether federal policies will be changed to head off economic consequences of the fiscal cliff, now is a good time to consider lightening up on high risk investments and focus on more defensive investments with the fiscal cliff deadline approaching. Even if the worst case scenario of approximately $600 Billion in automatic spending cuts and tax increases is avoided, significant federal spending cuts and tax increases are likely in 2013, which will likely negatively impact the United States economy and stock market.
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