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Fiscal Cliff Clouds Holiday Spirit

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The apparent stalemate in the Fiscal Cliff talks is most likely part of the tactics for both sides. It is only reasonable to expect them to haggle over each component of the final deal as one would do in a bazaar. Perhaps that’s the reason why the market isn’t overly concerned about the positions staked out by the two sides. We should be mindful, however, that the incentives for both sides are not perfectly aligned. As such, the odds of not reaching a deal in time to avoid the ‘cliff’ are not non-trivial, though they are small.

‘Cliff’ aside, we have a busy week on the economic calendar, with the November manufacturing ISM report coming out a little later. The expectation is that we will get a modest pullback from the October’s level of 51.7 due to Hurricane Sandy, but the index should remain in expansionary territory.

The most important economic report this week of course is the November non-farm payroll report on Friday. But as we saw with the weekly Jobless Claims data in November, the Friday jobs report will also most likely be distorted by Sandy. It is perhaps fair to assume that the market will look past even a very weak reading on Friday.

We will get a sense of the extent of hurricane distortions in the Friday payroll data from Wednesday’s jobs report from Automatic Data Processing (ADP - Free Report) . The service sector ISM survey on Wednesday likely will have limited storm related effects and should be around the same level as the month before.

The ‘Cliff’ debate will likely continue to monopolize the market’s attention most of this month. But at some stage, the focus will have to shift to the fourth quarter earnings season. The preponderance of negative guidance for the quarter has helped bring down expectations for fourth quarter earnings growth, but we haven’t seen much downward adjustment for full-year 2013  estimates which still show growth expectations in excess of 10%.

Given the broad economic weakness all around the world, it is unlikely that we will get growth anywhere near that level. My sense is that estimates for 2013 will start coming down as companies provide guidance on the fourth quarter earnings calls. As such, while Fiscal Cliff is justifiably the big issue for investors at this stage, we shouldn’t lose sight of the deteriorating earnings picture, either.

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