Stocks are increasingly vulnerable as the "fiscal cliff" deadline nears, but traders are still betting politicians will compromise on a deal to head it off, even if it's early in 2013.
There is also a bubbling sense that the economy is improving, and if Washington were not a factor, it could be gaining enough traction to serve as a spring board for stocks. Other trouble spots, like Europe, and China, are also showing signs of improvement, giving investors hope that the underpinnings of the global economy can only get stronger.
But politicians have been holding the markets hostage, as they head to the year-end deadline to fix the fiscal cliff. The so-called cliff is the more than $600 billion in expiring tax breaks and onset of automatic spending cuts that would take place if Congress fails to act.
"It's a game of chicken now," said Steve Massocca of Wedbush Securities. "The market's opinion is there's going to be some kind of deal, and this is going to get resolved in two to three weeks, and not right now, which is why the market is not acting that badly."
Stocks reacted to each new comment on the fiscal cliff Thursday, confirming to traders that a negative outcome is not priced in. Stocks first slumped Thursday after Senate Majority leader Harry Reid said a deal may not be made by the Dec. 31 deadline. The comments came shortly after the release of December consumer confidence showed a surprising drop to the lowest level since August, in response to fiscal cliff worries.
The market later erased much of those losses and moved into positive ground after word came that House Speaker John Boehner was calling House members back Sunday evening at 6 p.m. ET, suggesting he expects there to be a new bill for the House to vote on in time to avert the cliff. The House shut down for the holidays last Thursday after Boehner failed to get a vote on his "Plan B," which would have allowed tax increases on families earning $1 million or more.
Senate Minority Leader Mitch McConnell then spoke just before Thursday's market close, sending stocks back to negative territory. McConnell said he would see what the president proposes and that Republicans aren't going to write a blank check for whatever Democrats propose. The Dow finished the day down 18 at 13,096, and the S&P 500 was off 1 at 1418.
McConnell spoke as rumors circulated that a new plan was coming from the White House, which last offered $400,000 as an income threshold.
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Some analysts say there seems to be enough common ground despite the disagreements to get a deal done, and even if it is not by Monday, it could be in the next several weeks.
"I think that may be an excuse for why the market is holding in," said John Briggs, senior Treasury strategist at RBS. But Briggs said that dragging a deal into January is not an ideal solution, and the markets could be disturbed by it. "I think that even if a mini deal gets done, the debt ceiling is not going to be part of it, so we're going to be doing this whole thing over again in February or March."
Treasury yields moved in a relatively wide range intraday Thursday but ended the day barely changed. The 10-year yield was at 1.73 percent late in the day but had been above 1.78 percent and below 1.7 percent earlier.
"I was a little surprised that the last couple of days have been as complacent as they've been considering the lack of progress," Briggs said. "We were in a benefit of the doubt mode for a long time."
He said he is skeptical the stock market can continue to make much progress near term. "How much are asset prices going to rise when we have another confrontation in eight weeks?" he said. "I'm turning into more of an optimist as far as 2013 goes, but I'm finding it harder to be optimistic with that as a backdrop. I see more progress in the underlying economy. The housing market recovery is not a secret anymore and households have made a lot of progress getting balance sheets in order."
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Friday's data includes Chicago PMI at 9:55 a.m. ET, and pending home sales at 10 a.m.
Thursday's new home sales was the highest level since April, 2010 and jobless claims also showed improvement, falling to 350,000, while the four-week average fell to a near five year low of 356,750.