Will stocks fall off the cliff?

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Now that the election is behind us, national focus is zeroing in on the fiscal cliff, the Jan. 1 date when tax hikes and spending cuts automatically take effect. If Congress doesn’t come up with a solution by then, investors will face more than higher taxes. There’s the threat of a recession and a further drop in the stock market.

“The impact of various tax increases and reduction in, primarily, defense spending, is likely to reduce (gross domestic product) anywhere from 2.5 percent to 5 percent, based on most projections,” says Brent Fykes, senior investment partner at GenSpring, a wealth management firm catering to the ultrarich. “Given the current low growth in GDP, the fiscal cliff could result in a recession during the first half of 2013,” he adds. “That would most certainly result in a drop in the market.”

Many are speculating that even if Congress doesn’t come up with a solution by year-end, an economic crisis can be averted if it implements a plan in the first half of 2013. Fykes says in that case, the outcome for the economy and the markets will depend on what the plan is and how meaningfully it impacts the GDP.

The market already suffered a sharp selloff immediately following the election, signifying it hasn’t yet priced in the possibility of a fiscal cliff, Fykes says, and has room to fall further. “The markets are still sitting near all-time highs, even with slower earnings growth from companies reported in the third quarter and reduced forecasts for earnings in 2013.”

All of this uncertainty is creating a volatile stock market and leaving long-term growth investors worried about where to put their money. In these shaky financial times, it’s more important than it ever was to be diversified — not just among various equity sectors but also among fixed-income and alternative strategies.

Do you believe Congress will solve the fiscal cliff issues before the deadline?

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