Cooperate or brawl on fiscal cliff: Washington's next move?

Stocks could give Washington a pass until there are more signs of whether `fiscal cliff` negotiations will go smoothly or turn into a hot-headed showdown.

The market closed barely changed Monday. The Dow was down less than a point, at 12,815, and the S&P 500 was up less than a point at 1380. The bond market was closed, and many market participants were off for the Veteran`s Day holiday.

But when Wall Street is back to business Tuesday, cliff-watching will dominate. Aside from random remarks from political leaders, the markets are watching Friday`s meeting between Congressional leaders and President Barack Obama. Obama also meets with union leaders, business leaders and civic leaders ahead of that Friday meeting, which could set the tone for the resolution of the cliff.

The cliff is the USD 607 billion expiration of tax cuts and other programs, and the onset of automatic spending cuts Jan. 1 if Congress does not act.

The CBOE`s volatility index, the VIX, was sharply lower Monday, losing 10 percent to 16.68. "People are betting the market will be less volatile," said Steve Massocca of Wedbush Securities. "Typically, low volatility is correlated with a rising market but not always."

As for the discussions in Washington, "It`s hard to say because we haven`t gotten specifics yet. There`s a meeting this Friday. Coming out of that meeting there might be specifics. There`s talk now there`s going to be some kind of compromise," said Massocca.

Both Obama and House Speaker John Boehner said Friday that they are open to compromise, but they still appear apart on the idea of raising the tax rate on high income Americans.

Traders said it was encouraging that Boehner appeared to be pushing House Republicans to prepare for compromise. Stocks lost about 3.5 percent last week, following the election on worries the status quo outcome would lead to gridlock and push the economy off the cliff.

"I can`t see a move upward in equity prices absent a resolution to the fiscal cliff," said Mark Luschini, chief investment strategist at Janney Montgomery.

"We don`t know for certain, even if there is an adjustment to the capital gains tax rate, where it`s going to go. Fifty percent of stocks are held in tax advantaged accounts. It`s a moot point to some investors," he said.

Dividend stocks have been selling off on fear the Bush-era tax cuts will be allowed to expire, and the tax rate will revert to individual tax rates. Dividends are currently taxed at 15 percent and if Bush tax cuts expire, the top earners could pay taxes of 43.4 percent on dividends, including the new 3.8 percent healthcare-related tax on investment income.

Luschini said a lot of investors might not see the higher tax rate on dividends, which would hit individuals making $200,000 and couples earning $250,000 or more.

What to Watch

Several retailers report earnings ahead of the opening bell Tuesday, and Home Depot should disclose what type of impact Super Storm Sandy had on its profits. The stock is up 45 percent year-to-date, but it had a flat performance in the past month. It is expected to be a beneficiary of rebuilding.

Saks, Nordstrom, and TJX also report before the bell. Cisco reports after the close.

There is not much in the way of data Tuesday. The NFIB small business survey is reported at 7:30 a.m. ET and the federal budget is released at 2 p.m.