Post the November 6th election, much of the market focus has been on the Fiscal Cliff. That’s not to say that economic announcements, a Greek bailout, Hamas, and Sandy haven’t been factors; however, when you look at the market tape, the big moves have been made based on comments from Congressional leaders and the White House. Investors aren’t operating on rational thought, but on the emotional swing of sound bites from Washington D.C., as we swing from each branch of political posturing to the next.
If you’re tired of hearing the term, “fiscal cliff” you’re not alone. You’d think this was the most widely televised “disaster” to face the markets since sub-prime and Y2K before that. However, the media (and investors) haven’t really focused on the issue until after the elections. If you look at how many stories included the keyword “fiscal cliff” in the body, Bloomberg shows it clearly below that the market has only recently begun to tackle the issue. The fiscal cliff issue is coming to a climax soon because eventually, Congress will want to recess for the Holidays. In the last two years, we’ve seen Congress extend payroll and bush tax cuts, on average, about 15 days before expiration and we think it will be no different this time. Debating until the last minute and then electing to kick the can down the road.
Since the November 6th election, the S&P has fallen 14 points. Of course, it was more than that a couple of weeks ago before Congressional leaders stood together on November 16th in front of the White House. Shoulder to shoulder, practically holding hands they announced they’re going to work together to get the job done. Hey, what other profession out there do you see employees get on TV saying they’re going to do the job their employer paid them to do? I guess you could put sports players and coaches up there as well. The frustration comes when they don’t do the job we expect them to perform. Reassuring words are what you’re going to get on TV, or finger pointing. Here it was the former.
The emotional pendulum swung the other way in favor of hope after that conference. And for gun-toting traders, hope means buying stocks if you shoot your trades off selling the market one week and buying it the next. For many others, investors continued to abandon ship last week with money-market funds seeing .63 billion inflows for the six-day period ending Tuesday November 20th last week. Any guess how much is sitting in those money market funds yielding 0%? .602 trillion U.S. dollars. That sounds like a lot, and it is, but it has steadily dropped from a high near trillion early 2009. Instead of pouring into stocks with the market up 112% since March 2009, it’s been mainly going into bonds.
Republicans have placed revenues on the table and so it looked like a compromise might be had. That’s about the farthest we’ve come in fiscal talks between Congress, business leaders, and the President. All parties involved are asking for a balanced approach, and that means spending cuts attached to revenues. Grover Norquist, founder and president of Americans for Tax Reform, has called the requisite deal for spending cuts a “pink unicorn” signifying how difficult it seems for the government to cut spending, especially when it pertains to entitlements.
The political posturing continues.
Senator Reid on Tuesday said he was disappointed with the little progress made in the debt talks. This confirmed comments from Senator Dick Durbin over the weekend who said little progress had been made towards a compromise in the past two weeks as Congress was away for Thanksgiving. The stock market began to give back some of last week’s hope rally.
While on Wednesday, comments from John Boehner again swung the emotional pendulum from negative to positive as he reiterated he’d be willing to put revenues on the table if accompanied by spending cuts, while affirming his opposition to raising income tax rates. Boehner, like Senator Reid, sounded frustrated today, however, saying “First, despite the claims that the President supports a balanced approach, Democrats have yet to get serious about real spending cuts…and secondly, no substantive progress has been made in the talks between the White House and the House over the last two weeks.” His comments today swung the emotional pendulum with a 60 point drop in the Dow Jones industrial Average within minutes. Boehner basically put the ball in the Democrat’s court without signaling how much in spending cuts he’s looking for or from where.
Phil Buster Who?
Behind the Fiscal Cliff scenes, Senator Reid is pushing legislature to eliminate the filibuster. Its roots come from ancient Rome in which Roman Senator Cato would lecture until nightfall on a debate. Because the Senate would have to adjourn by dusk, the prolonged discussion was an effective tool by the minority to stall a vote and potentially end the debate. I’m all for streamlining the legislative process, but why the sudden change of heart? In 2005, Senator Reid opposed the Republicans for trying to eliminate the filibuster when his party was in the minority, calling it a sheer act of brute force.
Senator Reid’s power grab will not be taken lightly by the Republicans as the two parties try to compromise over the Fiscal Cliff. Voters maintained the status quo government on November 6th, without giving any party a clear mandate one way or the other. The American voters basically told both parties they agree with elements on both sides of the issues regarding spending and taxing issues, and they want Congress to work together on a balanced approach – something we’ve heard a lot of talk about. Now the question is whether they can walk the talk in the next couple of weeks.
The Non-cliff News
Meanwhile, we’ve had some bullish catalysts in the market over the past couple of weeks. The Greeks are going to get their next bailout tranche, something many had already expected after the Greeks had passed budget cuts a couple of weeks ago. All’s quiet in European debt land as sovereign yields continue to fall, even for Spain which has shied away from requesting aid outside of their bank bailout package this summer. It seems that the OMT policy from the European Central Bank continues to keep bond vigilantes at bay from shorting and selling sovereign bonds. Be mindful, however, that hedge funds and traders are quick to trade on the smell of blood. If European debt begins to upset the market, I’ll be sure to focus on it on Jim’s weekend radio show. Despite economic weakness and debt concerns in the European region persisting, rates continue to fall and stocks remain near 2012 highs.
Technically speaking, looking at the S&P 500 right now, the picture is as clear as mud. The bearish wedge that has developed over the last two years has broken down and completed. The last two weeks will either go down as the largest bear trap or the beginning of a top as the S&P rallies to retest the breakdown. It is critical that the S&P 500 get back above the 50-day moving average and the support trendline of the bearish wedge for the bullish premise to continue. The daily MACD triggered a buy signal on November 21st near the same level in June. In addition, it’s bullish that the S&P 500 is trading back above the 200-day moving average. Despite the near-term strength, there are still a number of factors that must be overcome for the bullish trend in the market to resume, and that warrants caution and strict discipline on holding/buying individual positions.
At PFS Group, we continue to give this cyclical bull market the benefit of the doubt. With central banks easing, we have seen crises that affect investor sentiment come and go since the 2009 bottom. We believe the current fiscal cliff crisis will end the same way. We believe a deal is likely, although it may happen at the last minute as happened in 2010 and 2011. We believe the main issues (debt and uncontrolled spending) will get kicked down the road for a later date while some small compromise will serve as a catalyst for the market to make another bullish run. We’re also due for another Federal Reserve Meeting next month in which we believe we’ll be introduced to more accommodation as Operation Twist comes to an end and QE3 gets beefed up. Remember that Operation Twist is sterilized easing as the Fed purchases long-term Treasuries while selling short-term Treasuries. If the Fed closes out the program and beefs up QE3, call it QE3.5, then it will be a net increase in money printing, and likely bullish for gold. The charts on gold and silver look phenomenal.
With Hurricane Sandy behind us and the repairs and reconstruction ahead, we believe that the economic indicators, which have been turning up again since the summer, will continue to improve. With the Greek bailout tranche approved, Europe is also in the rearview mirror for now. Spain has yet to approach the bailout funds of the EFSF or the ESM, but I don’t think they need to if their borrowing costs continue to fall with falling sovereign bond yields. Yes, deleveraging will need to continue, but there is something to be said about Ray Dalio’s beautiful deleveraging label on the current scenario that continues to play out.
