PM: Fiscal Cliff worries behind us?

PM Update

Stocks were flat on the last trading day of the month.  The 50dma is providing overhead resistance and breaking through this level should be met with skepticism.  We’ve come a long way and it wouldn’t be surprising to see the market pullback some.

MARKET BEHAVIOR

Stocks entered a holding pattern on the last day of the month.  We ended virtually unchanged on higher volume as portfolio managers adjusted their positions for month-end.  The last 10-minutes provided some excitement as the market surged higher, trying to breakout, only to give back most of those gains in the final 5-minutes.  Portfolio managers and index funds make their trades in the final minutes of the day and their jockeying made for those last-minute fireworks.

MARKET SENTIMENT

Technically we are still under the 50dma and it is providing overhead resistance.  The 50dma is a widely followed technical indicator and breaking through could trigger a wave of short-covering and breakout buying since many traders follow the same technical trading philosophy.  But given how far we’ve come, I would be suspicious of any breakout rally and recommend waiting  a couple of days to confirm it is the real thing.

Sentiment wise it seems like a lot of the fear of the Fiscal Cliff has evaporated.  A couple of weeks ago the market was selling off as politicians extended olive branches to each other, and now we are rallying as they use press conferences to throw barbs at each other.  A bit odd if you ask me, but that is standard operating procedure for the markets.

The market often looks ahead six months or more and could have already discounted the Fiscal Cliff .  Or the market could be sucking in the last of the momentum buyers before the rally fizzles and reverses lower.  While most of the market might cognitively acknowledge the Fiscal Cliff will eventually be resolved, the fear of the unknown can overpower rational thought and herd instinct compounds these impulses.  As humans we fear risk about 2.5 times more than a similar reward and this is why the stock market sells first and asks questions later.

TRADING OPPORTUNITIES

Are we on the verge of something like we saw in the summer of 2010 and again this summer?  I don’t think so because those two cases started from a level of high complacency after big rallies.  We have sold off since September and sentiment is already fairly low.  The market could get spooked by a bad headline out of Washington, but it should find a floor fairly quickly.  We could easily break the 200dma again and even challenge the recent 1343 low.  But don’t count on going lower than that.

Another scenario is pessimism is already elevated and the Fiscal Cliff worries over the last couple weeks scared off all the emotional traders, meaning there are very few sellers left to spook out of the market.  In that case we could continue rallying into the end of the year.

The easy trade is if market plunges on Monday.  The harder read is if we pop above the 50dma.  That could be the last gasp of this rally, or it could be a continuation move and  the rally resumes.  Short-squeezes are very short-lived phenomena and within a couple of days we’ll know if a break above the 50dma is going to stick.  If it can’t hold, expect a selloff through the 200dma.  If the breakout sticks, the market doesn’t want to sell off and the smart trade is buying and holding on.

INDIVIDUAL STOCKS

Surprisingly AAPL was left out of the broad markets recovery today and it finished off 0.7%.  Under normal circumstances this would be a red flag, but we might give AAPL the benefit of the doubt today simply because it is the most widely held stock and month-end window-dressing could be part of today’s weakness.  AAPL has rallied a good ways from the November 16th low and broad market weakness could push the stock down again.  Hold off buying AAPL for the time being because you might get a better opportunity over the next couple weeks.

SCORECARD

Looking back at recent calls from CrackedMarket:

November 26th, 2012  “The trend is lower and the trend is more likely to continue than reverse, so we should plan for further weakness.  But at the same time, bears are getting pretty aggressive and we might see a short-squeeze thrown in before heading lower just to keep things entertaining.  The market doesn’t like to be predictable and a short-squeeze before plunging lower would zing both sides and humiliate everyone equally.

At this point I am looking for a plunge lower on gigantic volume to signal this correction is bottoming.  I would be reluctant to buy a rebound from this level without a huge selloff.  Lacking that, the rally won’t have the ammunition and sentiment necessary to sustain a move higher.  The market rises on fear and we need to scare everyone to get this rally going.  The only exception I would consider is if the market traded strong for four or more days.  I could get on board with that kind of strength, but that rally wouldn’t have the same upside potential as a market that had a decisive shakeout.”

Stay safe