The Dow slipped 28 points Thursday to 12,542, and the S&P 500 was down 2 at 1353. As stocks have sold off, money has moved into Treasurys, driving rates to the lowest level since early September. Small cap stocks and momentum names have been harder hit, with the Russell down 7 percent since election night.
"So far, we've heard really nice things compared to what's likely to unfold before the end of the year," said Zane Brown, fixed income strategist at Lord Abbett. "I still think nothing's going to get done until the end of the year. I think we're in for a very ugly period of volatility."
The Congressional Budget Office predicts a first half recession next year if the economy hits the cliff. It expects growth to be cut by a half percent for the year, and it expects growth to resume in the second half. But many private forecasts see a worse outcome if the full cliff is realized, and the unknown is how businesses and economic activity will respond to the process in Washington. If there is acrimony and contentious grandstanding, like during the debt ceiling debate, the hit on the economy could be even bigger.
The stock selloff is being fueled in part by the expectation that capital gains taxes are likely to rise next year. Capital gains rates could rise from 15 percent to 20 percent, or 23.8 percent for the wealthiest tax payers if tax breaks expire.
Particularly slammed has been Apple, the favorite stock in many a portfolio and fund, and a ripe target for tax loss selling, or capital gains avoidance in future years. The stock is down about 25 percent but still up 30 percent year to date.
Stocks that pay dividends, like utilities, have been thrown out for fear they will be less valuable if their dividends are taxed at a new higher rate. That rate could rise to as high as 43.4 percent for the richest taxpayers if the Bush-era 15 percent rate is left to expire.
"The dividend taxation issue is my greatest fear because I don't really know how you react to dividend taxes going to 45 percent and capital gains going close to 25," Adams said, adding investors have not had to consider those factors for years.
The market sell off also comes at the tail end of a lackluster earnings season, with a lot of disappointment and many warnings for the fourth quarter. Companies have pulled back on spending, and are signaling they will continue to hold off. For that reason, Adams said she downgraded tech stocks to underweight.
"Not only are investors selling their lack-of-conviction names, but they're selling their winners as well. That reflects that the market environment has turned significantly more negative," said Adams.
"The combination of fundamentals and technicals are already working against the market," she said. "If policy makers can't swoop in to add a boost to confidence, they're only going to add to the pressures...the problem now is this policy overhang is having real economic impact."