Fiscal Cliff setup is in place & ready to go

Hi there, and welcome back to CRI's S&P 500 blog. Our peak at the SPY (S&P 500 depository trust units):

  The final week of 2012 brings us all to a very interesting point in the market. Due to political gridlock from Washington it would seem we here in North America are going to jump off the 'fiscal cliff' in unison come January 1st, 2013. Considering this was a term coined by a US government official, there really isn't any telling exactly what is going to happen to the North American economy once the calendar turns, but it is very interesting to watch the collective psychology of 'investors' as they hum-and-haw over the possibilities. Fundamentally, one could make the argument that the US government's balance sheet has long been due for some cleaning up and the broader market drivers (interest rates & corporate profits) are actually very supportive of higher not lower stock prices. Additionally, markets love split democratically elected governments. The more gridlock, the less that can be done to tinker with the market's underlying fundamentals. The 64k question really seems, do we get caught up in the short term 'panic' or do we approach our market participation from a Rational perspective and not get caught up in the short term hoop-la.

Rational overview:
Fundamentals: As pointed out above, the 'E' in current P/E ratios is still rather healthy. Additionally, the US Federal Reserve Board's current low short term interest rate policy is supportive of both yield curve driven earnings and the general cost of doing business going forward. Put it all together and one can make the arguement that the underlying fundamentals for corporate profits look ok going forward. Lastly, investor sentiment is currently rather poor. Last summer investors got a little ahead of themselves (with the likes of AAPL etc.) but now much of that euphoria is gone. Sanguine investors don't make the backdrop for stock market crashes. - corrections, maybe - crashes, no.

Technical: This market is a bit overdue for some sort of corrective price action. We have basically been heading straight up for more than a year now and find ourselves quite far away from serious support (200 period simple moving average - our 4 year business cycle - is currently more than 17% lower than current prices). Additionally, there are noticeable gaps to the downside (in that 200sma area) that ought to be filled in at some point down the road. Even a move back to our time tested '50%' level would imply a better than 10% correction from where we are now. Finally, as hopefully you can see from the chart above, the market is currently working a 'bullish wedge' pattern (Notice the converging Red and Blue trend lines). Unfortunately, these types of patterns often resolve themselves bearishly.

Seasonal: The seasonal underlying drivers were supportive of price moving higher into the end of the year both from a regular annual event driven basis (Santa Clause rally) and from the US Presidential election year cycle forces. Unfortunately, that bullish window is closing and typically the period from the first week of January through the middle of February has been met with selling pressure since the beginning of the current 'fear' cycle back in 2001. This seasonal  tendency shall continue for another five years (into anticipated peak Q3'17) and there is no reason to suspect otherwise this go round. Once through the middle of February we ought to see our regular seasonal pressures drive prices higher into the spring but that is at least a month and a half away.
 
Rational Summary: Put it all together at it would seem to me we are due for some price consolidation. But that does not mean we have broken down. Indeed, at worst, one can argue we are stuck in a very wide trading range at the present (146.29 to 133.75). Fundamentals would still support higher prices over the medium term but maybe a period of technical 'cleaning-up' is in order. With that said, one should determine what kind of market participant you are and then act accordingly.

Trader Stance: Traders have been given a nice shorting opportunity heading into the end of the calendar year with the rally into the daily OTE Short SS (70.5% retracement of previous sell-off) at 142.59. With stops just above the old highs 146.30 area (4 points of risk) and targets near the recent lows 133.75 (9 points of reward) this represented an attractive 2:1 reward to risk ratio. Aggressive traders could add to their short positions on the close below the 13ema (with stops on the added position just above last week's high). But given the fact that our 'fast' indicator (13ema) is still well above our 'slow' indicator (30sma) I don't think we are quite ready to break down in earnest just yet.
 
Investors Stance: While this commentary may sound boring and very repetitive, this camp has been well advised to be long and stay long for more than a year now. Those that took last year's investor 'buy' signal are well into double digits returns (if not more) considering dividends. As long as the 13ema remains above the 30sma I see no reason to touch long positions at the moment. Be long and stay long as we collectively climb the 'wall of worry'. 
 

That's all for this post,

Brian Beamish FCSI

The Canadian Rational Investor

the_rational_investor@yahoo.com
http://www.therationalinvestor.ca/RI_Tradents.php#sp500bloglink

http://www.therationalinvestor.ca