Fiscal cliff uncertainty to dominate markets

TORONTO — Talks aimed at avoiding the so-called “fiscal cliff ” will continue to cast a shadow over trading this week as markets begin to wind down for the Christmas-New Year’s holidays.

But traders will have some key economic data to serve as a possible distraction, including the latest reading on Canadian economic growth and retail sales. And in the U.S., investors will look to see if the strong run-up in housing starts carried on into November and whether worries about going over the fiscal cliff have taken a toll on consumer confidence.

Going over the cliff involves the automatic imposition of hundreds of billions of dollars in spending cuts and tax increases that could plunge the world’s largest economy back into recession and depress economies around the world.

The TSX ended last week up 136.95 points or 1.12 per cent despite concerns about whether U.S. politicians can head off the fiscal crisis. Mining stocks advanced on further signs of an expanding Chinese manufacturing sector and further lift was provided by Research In Motion Ltd., which gained 16.8 per cent to $13.88 during the week on increasing optimism that the new BlackBerry 10 smartphones can turn the company around. The line is being launched at the end of January.

Friday is supposed to be the deadline to reach a deal on the “fiscal cliff ” before the U.S. Congress recesses for Christmas.

But “a failure to get 10 years of deficit reduction wrapped up as a Christmas present need not preclude a temporary fix in a deal that simply softens next year’s bite, nor would delaying a vote into January be fatal,” CIBC World Markets chief economist Avery Shenfeld said.

Markets have generally held up well since the “fiscal cliff ” situation started to dominate market sentiment right after the Nov. 6 U.S. elections. In fact, the TSX and the Dow industrials have at least made up the initial losses registered in the immediate wake of the contest that left the U.S. political landscape largely unchanged, which in turn raised pessimism that Republicans and Democrats could bury deep ideological differences and strike a deal.

But volumes will start to thin this week and that could make for increased volatility.

“Trading volumes are going to become very very thin, very illiquid, very quickly,” said Andrew Pyle, investment adviser at Scotia McLeod in Peterborough, Ont.

“What can happen is you get the positive case where agreement is found, the illiquidity in the markets could give us a very sharp bounce. Alternatively some comments that we’re not going to get to an agreement could see some very sharp downswings in the market.”

On the economic front, expectations are fairly minimal for the October report on gross domestic product. Economists expect data will show GDP failing to grow for a third straight month.

Statistics Canada is expected to report that October retail sales rose by 0.1 per cent from September.

The agency also releases its consumer price index Friday, which is expected to show that inflation was kept in check amid a five per cent drop in gasoline prices during the month. Overall, the agency is expected to report that prices actually dipped 0.1 per cent month over month.

And negative news is expected from the Canadian housing sector. It is expected that existing home sales dropped by 0.89 per cent year over year during November.

Sales have suffered in recent months since Ottawa tightened ownership requirements. New mortgage rules put in place earlier this year reduce the maximum amortization term to 25 years.

In the U.S., economists expect that housing starts faltered during November after October’s reading left them up more than 40 per cent on a year-over-year basis.

“Not a significant pullback, but given the state of affairs it could be enough to upset market participants who think every month is a good month for housing,” Pyle added.

“That’s not quite the case.”

At the end of the week, traders will take in the latest reading on consumer confidence from the University of Michigan’s widely watched index.

“Equity markets have not been bad. That should, all things being equal, factor into an improvement in the consumer confidence index numbers,” Pyle said.

“The majority of individuals still think that some type of deal is going to be scrambled together with respect to the fiscal cliff and that we don’t get the worstcase scenario.”