Politicians reached an agreement to avoid the most significant consequences of the fiscal cliff. That noted, the temporary measures put in place to delay spending cuts, coupled with the looming debt-ceiling limit, mean that the fight will resume in early January after the new Congress is sworn in.

Despite the partial solution, we view the progress as a positive sign and (from an asset allocation perspective) plan to take a more aggressive, pro-cyclical stance in favor of equities versus bonds as a result.  

 After a long battle, Congress approved a deal that permanently extends the Bush-era income tax cuts for 99.4% of the nation's taxpayers. The top 0.6% of earners, which includes individuals earning $400,000 or more and households earning $450,000 or more, will see their marginal tax rate increase 4.6%, to 39.6%.

Other tax increases include a hike in the payroll tax from 4.2% to 6.2%, a rise in the inheritance tax and a cap on itemized deductions for individuals earning at least $250,000 and households earning at least $300,000. Overall, the tax increases are expected to generate $600 billion in new revenues over ten years.

What's Next?

While the tax-hike concerns have been addressed, the automatic spending cuts associated with the fiscal cliff have been temporarily delayed for two months. A more permanent solution is required. Additionally, the nation is once again approaching its debt ceiling limit. Efforts to raise the limit are certain to be contentious.

Together, these two issues suggest that the fiscal fight will continue to be grueling, and will include another ugly showdown in the weeks ahead as Republicans try to wrest cuts in entitlements as a quid pro quo for increasing the debt ceiling. President Obama said he will not negotiate on this basis, but he may not have a choice. Looking beyond the noise in Washington, the overall economic outlook remains positive as nearly all data points suggest a continuation of economic growth, albeit at a slow pace.

Market reaction supports this outlook. As fiscal cliff negotiations came down to the wire, the stock market fell just 2% in the last full week of the year. We believe the lack of reaction by investors may reflect a willingness to look beyond the rhetoric and the politics within the context of a broadly improving economy. It is a perspective that we share.

As always, Crissy and I, along with our staff, are here to assist you as we begin our New Year. While we may not be able to predict the future, we can help you navigate these volatile times.