I wrote last week about my thoughts on the “Fiscal Cliff Rally” on a resolution:
The Fiscal Cliff Rally. It’s been a favorite expression among traders for the past few weeks. It implies that the politicians will eventually come to some sort of compromise, triggering a rally as the worst-case scenario does not come to pass.
Who is really expecting the worst-case scenario at this point? I imagine very few traders (and none who I interact with) expect no compromise and an immediate fiscal contraction. The large majority expect a kick-the-can compromise that puts off the large decisions for a later date. If that’s true, then how much of the Fiscal Cliff Rally is priced in?
The CotD post went on to show several situations in the last 3 years where the market anticipated an event, only to sell off or rally once the good or bad event came to pass.
To emphasize the importance of this psychology, here is a chart from the WSJ this morning:
Look at the price action ahead of the debt ceiling talks last year. The stock market actually held up throughout the negotiation period as traders anticipated an eventual agreement. In fact, an agreement was eventually reached before the debt ceiling deadline, but the market simply started falling once the news of an agreement was released.
We think a similar setup exists this time around. What’s amazing is how quickly traders and investors forget what happened. Many traders I talk to think the S&P downgrade of the U.S. credit rating caused last year’s selling, when that news only came after the market had made most of its fall. Instead, these drawn-out political negotiations lend themselves to classic “buy the rumor, sell the news” type psychology.
Markets overnight:
- Weekend news that Boehner was willing to accept tax increases on millionaires gave a bid to risk on Sunday evening. But markets are now mostly mixed after the initial pop.
- Japanese elections this weekend yielded the expected outcome, with Shinzo Abe becoming prime minister and strong parliamentary gains by the LDP. The yen initially hit 2 year lows against the dollar, but this seems like another buy the rumor, sell the news event.
- Asia was mixed, with Japan and Shanghai higher, and most other markets lower, all moves less than 1%.
- Europe opened flat and is now down 0.3%. SPX futures were up 0.6% on the open, now up 0.2%.
- AAPL was downgraded to neutral at Citi, and stock trading $503 pre-market right now
- Dollar mostly higher, Treasuries a bit lower, commodities lower.