US markets could end 2012 with craziest trading day of the year

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VIX 12-28-12
Wall Street’s “fear gauge” finally freaks out over the cliff.
Image: Yahoo Finance

For most exchanges, there’s still one trading day left in the year, Monday Dec. 31, and it’s shaping up to be one of the most volatile we’ve seen in 2012. The cause: US leaders remain at an impasse over the so-called “fiscal cliff,” a package of austerity measures that would slash government spending, impose new taxes, and renew debates about the debt ceiling.

The fear in markets was obvious during the last hour of US trading Friday. Wall Street’s “fear gauge”—the S&P 500 Volatility Index better known as the VIX—shot up nearly 17% as Congressional leaders left a meeting without a deal.

Either way you play it, Monday will be a crazy day for markets. On one hand, were negotiations to remain unresolved throughout the day, one would expect trepidation over the lack of a deal to take a serious toll on markets. The cliff altogether amounts to 5% of US GDP, and it’s impossible to conceive that the impact of this fiscal contraction would not pinch consumers and businesses.

Then again, many investors see the cliff and the political gridlock that’s accompanied it as the final obstacle preventing the US economy from taking off in the new year. Promising signs in housing markets, falling unemployment, and the end of a presidential election that clarified the direction of the nation for the next four years suggest a potential end to the economic uncertainty that has curtailed growth over the last year. Continuing preoccupation about when exactly the deal will get solved may have stopped investors from taking risks up until now, but if the worst of the cliff were resolved before the close of trading on Monday, we could see a surge in confidence.