Macro Wrap – Fiscal Cliff Rally?

by Enis January 2, 2013 7:48 am • Commentary

Welcome to 2013.  SPX futures are up 20 points after the House passed the Senate’s fiscal cliff compromise.  What do I think of the Fiscal Cliff Rally?  Here is what I wrote on Dec. 10th in my CotD post with regards to a potential rally when a deal was reached:


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?

We can look to market history to better illustrate my point.  Over the last 3 years, we’ve had several long-anticipated policy events that eventually came to pass.  The most notable in my mind were the initiation of QE2 (telegraphed months in advance), the resolution of last year’s debt ceiling talks in a kick-the-can compromise that has brought us to the current impasse, the announcement of Operation Twist (which had much less lead time, but one situation I want to discuss anyways), and the announcement of QE3.

Here is the 3 year chart of the SPX illustrating those events with their respective circles:



Fast forward to today, Jan. 2nd.  A deal was finally reached, and SPX futures have rallied 55 points since Monday morning.  How much of the resolution has been priced in?

In my view, corporate earnings are ultimately the driver of stocks.  But there are a significant number of psychological shifts that move stocks over the course of weeks and months.  Earnings for S&P 500 companies have clearly slowed in the last 6 months, and earnings season starts in earnest again in 2 weeks.  I anticipate that the market’s next focus will be on whether companies are making more money than expected or not, simple as that.

As such, I place more emphasis on upcoming corporate results for the the market’s next major direction rather than the completion of a long-awaited deal.  However, I will be watching price action closely over the next few days to get a feel for which sectors the major fund managers seem to prefer to start 2013.  The first month of any year often involves more dispersion between sector performance than normal as funds change their overweights and underweights.

Markets Overnight:

  • Global Stock Markets started 2013 on a strong note.  Hong Kong led Asian indices higher, closing up almost 3%.  Other Asian indices were up between 0.5 and 1.5%.
  • Europe is higher around 2%.  European PMI data came in close to expectations, but the main driver of shares is the U.S. fiscal cliff deal.
  • Risk-on is the primary theme.  The dollar and Treasury bonds are lower, and commodities broadly higher.
  • The ISM manufacturing index will be released at 10am, along with construction spending data.  Non-farm payrolls and ISM non-manufacturing data comes out on Friday.