History about to repeat itself?

Well, as predicted politicians in the US have taken the Fiscal Cliff negotiations to the edge. The political process in the US has a habit of doing this, both sides usually playing their cards close to their chest right up to the final round, then bluffing and counter bluffing, not wanting to be seen to give anything based on their principles. In reality principles are difficult things to stick with when it comes to politics, they can get you into a world of hurt when the financial markets decide they don't like them.

2008 saw a taste of that when Congress initially voted against TARP. On principle there were many good reasons to vote against it, but faced with a market backlash of big market falls, the politicians quickly got back together to say what was for many perhaps a reluctant yes. Back then the market was in free fall as the financial crisis took hold, markets falling on the back of the TARP vote was the threat of worse to come if the politicians didn't play ball.

On Sept 15, 2008, Lehman Bros filed for bankruptcy sending the Dow plummeting 504 points.

On Sept 17, the Dow falls 449 points in reaction to AIG bailout.

On Sept 29, the Dow tumbles 777 points after House votes "No" on TARP.

On Oct 3, the House passes Financial Rescue Plan (TARP) The Dow falls 818 points.



Even though the politicians did eventually play ball, I recall at the time the markets felt that TARP was probably not enough. Ultimately the markets turned around, recovering much ground over the last three years to the constant dismay of permabears. Volatility has continued as has political and economic uncertainty, but markets are up.

Roll forward to 2011 and the debt ceiling talks. As the talks carried on markets began to fall. While the politicians finally agreed on raising the ceiling, markets were not entirely convinced and when Standard and Poor's downgraded U.S. credit, the Dow dropped by 630 points, or 5.5 percent on 8th August. Still, markets managed to turn it around again, 2012 was for the most part a pretty good year and we did get an early Santa rally largely on the back of Fiscal Cliff hopes of a deal being done.

The danger here is that as we are now getting close to the final hour again, markets will feel the need to send a message if the politicians go over the cliff. Or as some have argued, maybe that's a slope as the financial world doesn't end at midnight if no deal is done, the cliff is more likely to be a market one given the way they tend to react when they don't get what they want.

For markets, because of the Santa "fiscal cliff" rally, there is plenty of room to fall if they decide to send that message. This may have already started in the US with a little sell off to end last week, it isn't that difficult to see sell off days over the next week or two of 1-4% a day.

In fact, the markets may decide the bigger the sell off the better, because they know the politicians will be watching. As always, the big markets that sell off big time are the stock markets. In reality, these markets are small compared to for instance the money and Forex markets, the amount of daily trade on the stock market is tiny compared to the currencies, but in terms of media exposure and sending a message it is massive. Politicians usually get that message fairly quickly.

So, don't be surprised if history repeats yet again. Don't be surprised if in a week or two time we are 15-20% lower. The bigger surprise will be if there is no sell off in the event of a Fiscal Cliff carry over. Of course, if a deal comes markets may well breath a sigh of relief and we could be going up again, that is until we get to raising the debt ceiling part 2, the 2013 follow up. Then, the political game and the market will they won't they and what message do we need to send, starts all over again.