Highlights -
Confidence has gone over the cliff, but economic activity remains on solid ground-leaving investors standing on the edge. -
If fears are realized, we expect economic activity to fall and a recession to take place in 2013. -
The debt ceiling may be another fiscal cliff that may weigh on consumer and business confidence and increasingly affect economic activity in the first quarter of 2013. Standing on the Edge As the battle rages on in Washington over the tax increases and spending cuts, known as the fiscal cliff, their impact has already been felt in some ways and not in others. Confidence has taken a hit, while activity has not-yet. While a deal has yet to be struck, steps could be taken to blunt the initial tax and spending impacts of temporarily going over the fiscal cliff to minimize the economic and market damage until a deal can be finalized. Treasury Secretary Geithner has the authority to leave the IRSincome withholding tables unchanged-and so far has not communicated any changes, so thatemployers would not withhold any more in taxes from employees' paychecks in 2013, despite the higher rates going into effect. In addition, even though the sequestered automatic spending cuts will go into effect at the start of the year, federal agencies can accelerate their spending early in the year with the intention of relief emerging from a deal or of making up for the cuts later in the year. While some of the direct impacts of the fiscal cliff may be mitigated or delayed, such as the above-referenced higher tax rates and spending cutbacks, some indirect impact has already been felt. -
Consumer Confidence - The widely followed consumer confidence indexes from the Conference Board and University of Michigan sunk to their lowest levels since stocks' 2012 low point in August. The last time confidence turned negative so quickly was in August 2011, amid the debt ceiling debacle and U.S. credit rating downgrade. However, then it dropped to the low 50s rather than just the low 70s, where it stands today. So while confidence has already been affected, there is room for significantly more downside. 
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Business Confidence - Similar to consumer confidence, business confidence also took a dive as the cliff nears. The National Federation of Independent Business's Optimism Index fell sharply in November to the lowest reading in almost three years [Figure 1]. November registered the biggest drop in monthly records going back to 1986. Despite solid fourth quarter stock market performance, U.S. initial public offerings raised only about $44 billion in the fourth quarter, the lowest quarterly total during 2012-even weaker than the spring quarter when stocks were falling-as companies lacked the confidence to come to market. On the other hand, activity in key economically sensitive areas has not seen any impact yet. -
Consumer Spending on Big Ticket Items - Despite the high likelihood of an economic recession should we go over the cliff, highly economically sensitive areas of the economy, such as auto sales and home construction, have showed no signs of slowing, much less declining. In fact, both are reaching levels not seen since the start of the Great Recession of 2008-09. Existing homes sold at their strongest pace in more than two years in November, and building permits reached a four-year high. Car sales hit a four-year high in November [Figure 2]. 
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Business Output - Manufacturing, which struggled during much of 2012, has showed signs of rebounding in recent months. Industrial production jumped by the most in two years, and orders for business equipment climbed for a second month. The regional manufacturing surveys outside of Hurricane Sandy-impacted areas rose and reflected expanding output. Indicators of service sector production also are on the rise. Confidence has already gone over the cliff, but economic activity remains on solid ground-leaving investors standing on the edge with an unsteady stock market that has been up one week and down the next during December. If the fears are realized, we expect economic activity to fall and a recession to take place in 2013, along with a drop for the stock market. A small deal designed to mitigate some of the consequences of the current fiscal cliff may be passed in the next few days. The negative economic impact would depend on the composition of the deal. While it could lead to a short-term bounce in sentiment, it may not last. This is because a small deal would be unlikely to address a debt ceiling agreement. The government has hit the $16.4 trillion limit, and the Treasury department will begin using extraordinary measures to finance deficits into 2013. These measures may last about two months before threatening more drastic measures, making the limit on U.S. borrowing authority another fiscal cliff-that may weigh on consumer and business confidence and increasingly affect economic activity-that needs to be dealt with in the first quarter of 2013. IMPORTANT DISCLOSURES The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Stock investing involves risk, including the risk of loss. The National Federation of Independent Business Optimism Index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members. The index is a composite of ten seasonally adjusted components based on questions on the following: plans to increase employment, plans to make capital outlays, plans to increase inventories, expect economy to improve, expect real sales higher, current inventory, current job opening, expected credit conditions, now a good time to expand, and earnings trend. This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. LPL Financial, Member FINRA/SIPC Tracking # 1-128866 | Exp. 12/13 | 
