Temporary Fixes

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The Real Cliff Is Of A Different Nature Than What Is Being Reported

The stock market is hoping for a deal, any deal with regard to the fiscal cliff. The problem is that even if there is a makeshift deal that stalls or delays the mandatory cuts and tax increases, no long term solution will emerge from this.

Last week we noted that this market is in a dangerous position. Nothing has changed in that regard. Yet, the bigger problem is that the economy is also in danger.

This is fairly simple if you think about it. After the Great Depression, the Glass-Steagall Act separated investment banking from community banking. What that really smart law did was to create two distinct pools of money in the world, the Wall Street money pool and the real people money pool.

What it also did was that it separated the effects of what happened in one place from the other, at least to some degree. Yes, recessions on Main Street were still reflected in stock prices. And bad times on Wall Street were reflected on Main Street. What we're saying is that the effects of prior recessions, weren't as significant as they have been in this recession.

When Clinton and Greenspan repealed the Glass-Steagall Act, the walls between the crazy money on Wall Street and the more responsible real life money on Main Street disappeared. That means that when the guys on the right side of the trade in the subprime mortgage derivatives collected on their debt, they got real money and Wall Street crazy money.

That's the major reason things are so bad now. The Wall Street money is gone along with the Main Street money that was comingled with it in bank ledgers around the world. That's why this crisis is different.

What does this have to do with the fiscal cliff? Well, it's the major contributing factor in many ways because there is no money anywhere, on Wall Street or Main Street to start or run businesses, to pay employees, to buy equipment, and to pay taxes.

All of the money is gone. It's in the accounts of the guys who made the right call in 2007 and 2008 when the subprime mortgage crisis hit the critical point and the economy crashed. Bernanke can't print enough money to get us out of this without reinstating the wall that separated real life money from Wall Street crazy money.

We don't need a bill to reverse the fiscal cliff. We need to demolish the fiscal cliff by restoring the dividing line between Wall Street crazy money and the money that real life people earn, invest, and pay taxes with.

Until Congress and the President realize this, we will continue to slide from crisis to crisis.

The Markets

spx 28 dec 2012
Chart Courtesy of StockCharts.com

The stock market looked set to open higher on the last trading day of the year but failed to do so. The hope for traders, the market, and the economy is that some kind of deal averts the fiscal cliff. The odds of such a deal are no worse than 50-50. The problem with that line of thinking is that no one knows what kind of deal, if any will be delivered, and for how long any deal can keep the whole process that we've been going through from happening again.

The S & P 500 (SPX) took a beating last week logging four down days for the trading period. The index has fallen for five of the last trading days. It has taken out the support of the 20 and 50 day moving average but did not fall below 1400.

All this may change for the positive, or may turn more negative depending on what kind of deal, if any actually emerges out of the emergency, last minute talks between the Democrats and the Republicans.

rut 28 dec 2012
Chart Courtesy of StockCharts.com

The Russell 2000 index of small stocks (RUT) fell a lot less than the S & P 500. The index remained above its 20 and 50-day moving averages, and remains in a rising short term trend.

This is important because, if there is a deal, and if there is a rally, small stocks may become the market's leadership sector. We already have an open position in the Small Cap ETF (IWM). Thus, if there is a rally, we are already well positioned to profit from it.

naad 28 dec 2012
Chart Courtesy of StockCharts.com

The Nasdaq Advance Decline line (NAAD) made a new high on Thursday, 12-20, but rolled over on 12-21. By the end of trading on 12-28, the line had broken below key support, and seemed to be heading lower.

There are two things to remember. If there is a fiscal cliff deal, and the market likes it, none of this may matter. On the flip side, if there is a deal and this indicator remains negative, that would be an important sign as it would tell us that the market is extremely vulnerable.

nahl 28 dec 2012
Chart Courtesy of StockCharts.com

The Nasdaq Hi-Lo line (NAHL) had been acting fairly well of late. But as with the rest of the market, except the small stocks, the strain of the fiscal cliff negotiations also dented this indicator. Still, none of this may matter if there is a deal, and if the market likes the deal.

Conclusion

The stock market is at the mercy of the failure, success, and details of any fiscal cliff deal. There has to be a deal. It has to make some sense. And the market has to like it. If these three criteria are not met, we could see lower prices.

As the last trading day of the year unfolds, we expect volatility. The early close for some markets and thin trading conditions are likely to add to the potential strangeness of the day.

We still remain very short term oriented, trading on a day to day basis and recommending small positions. This has served us well. We are not budging from this strategy.

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