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Bungee Jump Off 'Cliff' Should Please Wall Street

Per Eriksson | The Image Bank | Getty Images

U.S. stocks surged at the open Wednesday and are set to move higher in the short term on a temporary fix to the "fiscal cliff."

Risk assets rallied globally, with Asian stocks at five-month highs and European stocks up about two percent after the U.S. House approved a plan to head off the expiration of many tax breaks and other measures. Oil surged nearly two percent, and copper and silver led metals markets higher.

The S&P 500 was up more than two percent in early trading, as growth-oriented sectors, like financials, tech and industrials led the rally. Even utilities, the only losing sector in 2012, jumped 1.5 percent, as investors rebuilt dividend-paying portfolios, sold because of concerns dividend taxes would rise sharply. Under the plan, dividend tax rates rose to 20 percent from 15 percent.

Markets, however, will soon turn their attention to the unfinished business of Congress - which is whether new spending cuts and tax reform can provide a longer term fix for the U.S. fiscal crisis.

That debate should come to a head in the next couple months as Congress grapples with the debt ceiling limit, expected to have been already reached by the U.S. Monday, but forestalled by the Treasury for several months.

After a shaky reception, the House Tuesday evening adopted the Senate's Band-Aid bill to avoid the "fiscal cliff." The House gave up efforts to vote on an amended version of the Senate bill and passed the Senate plan. The amendments would have added spending cuts but that version did not win enough support for a vote.

The Senate bill, approved in the early hours of the new year, stopped the reversal of Bush-era tax breaks from hitting about 99 percent of taxpayers and permanently ends expansion of the alternative minimum tax, among other measures. But it failed to offer new spending cuts and it postponed a range of cuts, requiring further congressional debate. Republican House members bristled at the bill's lack of spending cuts.

"The immediate reaction on Wall Street will be positive," said Todd Schoenberger of Land Colt Capital. "...However, the same 2012 problems persist: A fragile economy, anemic job growth, a decimated household balance sheet. Considering there are so many headwinds facing the economy, including the debt ceiling negotiation in 60 days, the smart money knows the bullish sentiment will be short-lived. The lesson for investors here is 'buyer beware.'"

The adopted plan leaves plenty of work for the new Congress, including the debt-ceiling limit. JP Morgan economists projected the plan shaves 1 percent from growth in 2013.


(Read More: Here's What the Senate 'Fiscal Cliff' Deal Looks Like)

There was a lot of optimism in the market Monday, with stocks staging a late day rally to close out 2012 as just word of a White House-Senate deal filtered through the market.

"The cliff got smoothed today," Steve Massocca of Wedbush Securities said Monday.

Technically, given that the Congress didn't pass the legislation in 2012, the U.S. went over the cliff at midnight Monday night into Tuesday, when tax increases and spending cuts would have kicked in. However, the legislation is basically backdated. So, a quick resolution makes it more like "bungee jumping" — falling over the cliff and then bouncing back above it.

Under the deal, tax hikes will be avoided for most Americans, but raised for individuals earning more than $400,000 a year and couples earning $450,000. There were also changes in deductions that will affect more taxpayers, and all taxpayers will pay two percent more as the payroll tax holiday ends. The "fiscal cliff" was the $600 billion expiration of tax cuts and the onset of spending cuts that were set to take place starting Jan. 1 and many elements of it still require action.

(Read More: All Eyes on House After Senate Passes 'Fiscal Cliff' Deal)

As the market closed Monday though, it was widely expected that both houses would vote on a deal in the next few days.

The Dow was up 166 at 13104, a gain of 1.3 percent Monday, and the S&P 500 jumped 1.7 percent to 1426, its best final day of the year since 1974. The Nasdaq was the biggest winner, rising 2 percent to 3019, ending 2012 with a 16 percent gain. The Dow was up 7.3 percent, and the S&P 500 was up 13.4 percent for the year.

Of the major S&P sectors, the financials were the standout in 2012, with a gain of 26 percent for the year. One of the components, Bank of America, was up more than 100 percent. The second best sector was consumer discretionary, up 22 percent. The only losing sector was utilities, down 2.9 percent.

Stocks were negative for the fourth quarter, with the S&P down 1 percent. Since 1928, the S&P has declined in the fourth quarter just four times in years when the index also had scored double-digit gains. In each case, the market rose an average 12.2 percent in the next year.

(Read more: S&P 500 Soars 13% in 2012, Logs Best Gain in 3 Years)

"It's a good sign for the economy short term but it's not a good sign for debt and deficits longer term," said Gary Thayer, chief macrostrategist with Wells Fargo Advisors.

"We'll see whether these negotiations, which we're not really seeing the insides of are setting the stage for more fights or an easier approval," Thayer said. Analysts are braced for the next battle in Washington,the debt ceiling, which needs to be dealt with in the very near future.Congress is expected to tackle tougher spending and tax issues as it deals with the debt ceiling.

"We still have a lot of uncertainty with the debt ceiling coming up, but I think a lot of investors are taking a lot of this uncertainty in stride," Thayer said. "It's kind of encouraging that we're not seeing a lot of overreaction to the news."

BTIG global market strategist Dan Greenhaus said it's possible stocks won't react as much as expected to the debt ceiling discussions in the next couple of months, since Congress appears to be able to solve issues in the final hour. "Why would I mark down assets when they fix it at the last possible second," he said.

(Read more: Iuorio: Here's Why I Think Equity Markets Will Do Well in 2013)

So stocks start the year focused on resolution of the cliff,and on a few economic reports. Manufacturing PMI for December is released at 8:58 a.m. ET Wednesday, and ISM manufacturing and construction spending are both at 10 a.m. At 2 p.m., minutes of the last Fed meeting are released.

The Fed, at its last meeting, extended its purchases of Treasury securities, and it is the Fed that should continue helping stocks.

"I just think with the market, with interest rates so low,the tendency is for the market to go higher, not lower," said Massocca.

"If the S&P can get back above 1450, we'll be back above September highs if that can happen," he said. "The other thing that's going to come into focus is fourth-quarter earnings which I don't think are that good. That's a real issue. I think that could hold the market back."

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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