Stocks leap higher on 'fiscal cliff' hopes

NEW YORK -- Stocks staged a rally Monday afternoon on signs a deal in the "fiscal cliff" was near, with the Dow Jones industrial average closing up 166 points, or 1.3%.

Jumping higher were the Nasdaq composite, up 60 points or 2% and the S&P 500, gaining 24 points or 1.7%.

The Dow jumped more than 130 points to about 13,068 around 3 p.m. ET after Senate Minority Leader Mitch McConnell said a deal was near to avoid raising taxes on most Americans.

U.S. stocks had struggled for most of the last day of the year, with the "fiscal cliff" just hours away and Republicans and Democrats yet to hammer out a budget deal.

The Dow opened lower, with investors disappointed that politicians hadn't reached an agreement over a weekend of terse, stop-and-go negotiating. With no clarity on whether a deal would get done, and what it would look like if it did, the Dow spent the morning flitting between small gains and losses.

The Dow and the other major stock indexes turned higher at midday after a few signs that a deal was emerging. The Associated Press and other media outlets reported that both sides had agreed on a few key points on taxes and unemployment benefits.

If politicians can't agree on a deal by midnight, then higher taxes and lower government spending will automatically kick in Tuesday - the so-called fiscal cliff. That would hurt the economy, many investors believe. But what might hurt more, they add, is the psychological impact of knowing that the government that can't agree on a budget.

"We're having a fragile recovery, with the pain of 2008 still fresh on everybody's mind," said Joe Heider, principal at Rehmann Group outside Cleveland. "It's fear of the unknown. And fear is one of the greatest drivers of the financial markets."

It's difficult to discern how a deal, or lack of a deal, might affect the stock market. From mid-November through roughly mid-December, the stock market rose more or less steadily, despite the "fiscal cliff" looming on the horizon. It wasn't until shortly before Christmas that the "cliff" finally scared investors enough to send the market down.

Some investors are unruffled by the approaching "cliff." Even if Republicans and Democrats can't reach a deal, some investors think the effect of the higher taxes and lower government spending would be more like the anti-climactic Y2K scare than a true Armageddon. The impact would be felt only gradually - for example, workers might get more taxes withheld from their first couple of paychecks in the new year - but then Congress could always retroactively repeal those higher taxes, these investors reason.

Others are more concerned. The higher taxes and lower government spending could take more than $600 billion out of the U.S. economy and send it back into recession. Politically, the U.S. would send a message that its lawmakers can't cooperate. And without a deal, investors would have no good read on the country's long-term policy for taxes and spending, or how the government plans to eventually trim its deficit.

Tim Speiss, partner in charge of the personal wealth advisers practice at EisnerAmper in New York, followed the "cliff" negotiations on Monday and wondered if the U.S. would get its debt rating cut again. The Standard & Poor's ratings agency cut its rating of the U.S. amid similar negotiations, when lawmakers were arguing over the government's borrowing limit in August 2011. S&P said at the time that "America's governance and policymaking (is) becoming less stable, less effective, and less predictable." Its rating cut sent the stock market into a tailspin.

The other major ratings agencies, Moody's and Fitch, have suggested that they might lower their ratings of the U.S. if the country goes over the "fiscal cliff."

"That is, unfortunately, the big story," Speiss said.

It's also one of the only stories. There's been little other news to trade on during the holiday season, giving the "fiscal cliff" drama outsized influence. No major companies are scheduled to report earnings this week, and the major economic indicator this week, the government's monthly jobs report, won't be released until Friday.

Trading volume has also been light, with many investors still on vacation. That also makes the market more susceptible to getting yanked around: With fewer shares trading hands, the market can be moved by relatively small trades.

Last week, about 2.2 billion shares traded hands each day on average. Throughout the year, the average has been closer to 3.6 billion.

The yield on the benchmark 10-year Treasury note rose to 1.76% from 1.70% late Friday.

Some of the best-performing stocks for the year were those that had been hammered in 2011. Homebuilder PulteGroup, appliance maker Whirlpool and Bank of America all more than doubled over the year, after falling by double-digit percentages in 2011.

Some of the worst performers of the year were Best Buy, Hewlett-Packard and J.C. Penney. All are struggling to keep up with competitors who have adapted more quickly to changing technologies and changing customer tastes. They were all up Monday, but were each down at least 45% for the year.

USA Today