Revised Fiscal Cliff View

Having seen the market play out with extreme strength despite Washington headlines that would shake out any ordinary market, the script has changed.  It tells me that we won't get much of a dip until the fiscal cliff deal, as hedge funds are still piling in.  It is the one catalyst that keeps bulls hopeful and bears afraid of being short.  It doesn't mean we can't get a small pullback, but emphasis is on small.  I don't see SPX going below 1385 before the cliff deal. 

And it will be a watered down deal which will be celebrated for maybe 1 or 2 days, and then back to reality.  That reality is weakening earnings and higher taxes in 2013.  The bears will have to wait till early 2013 to get any meaningful downside in this market, as the buy after fiscal cliff deal money comes in at year end. 

We probably get to 1430 by early next week where we'll likely stall out but not drop much.

Strong as an Ox

Hedge funds are chasing here, that is what they do.  On the upside and downside.  It's not their money!  The dip lasted for all of 30 minutes before we went screaming higher.  That tells me just one thing:  there is a big pool of money looking to get in.  Those hedge funds are probably in the 6th inning of their accumulation, so we're probably about 2/3rd done.  Usually we start going back down in the 8th or 9th inning right when the tickle me elmo hedge funds get long and strong before the crap hits the fan. 

With the beginning of December coming up, I am sure the hedge funds will be anxious to buy ahead of the fiscal cliff deal and the positive seasonality.  By the middle of next week, I will be looking to aggressively short this market, if it's trading around 1420. 

Fiscal Cliff Bumps

The fiscal cliff deal will not be as easy as the market is thinking.  No one can be 100% sure what the government will do with the fiscal cliff, but if the past is repeated, the deal will be done in the final hour with a lot of grandstanding, political posturing, and refusal to yield.  This should be unsettling for the markets in the short term, probably in the next 2 weeks. 

I would be surprised if the Republicans would give in on the tax rate hike for the rich so easily without a fight.  And this time, Obama is not running for re-election so he won't cave so easily into extending those Bush tax cuts.  Expecting a fight on both sides at least in the initial stages of the negotiation, which is contrary to the current belief that both sides are eager to get a quick deal done.  The return of Congress from Thanksgiving break is the last thing the bulls want to see.  The huge rally over the past week has set up us for a healthy pullback on any signs of a less than smooth fiscal cliff negotiation.

Still in a Downtrend

We had a really sharp rally from the lows on Friday and all of a sudden we're supposed to keep squeezing higher?  The risk reward for a long is very poor here unless you have a V bottom.  V bottoms are not common, they just seem that way because we had so many in 2009 and even a few in 2010 and 2011.  They usually occur in the most bullish of markets where demand for equities is high or equities are so cheap that they are coiled to go higher.  Neither is the case now. 

All the paper napkin technicians are suddenly constructive on the market, when they were bearish late last week.  Don't buy the hype, we're going to have to test those levels from Friday again before we make a meaningful bottom. 

Expecting a Weak Day

Batten down the hatches, we're probably going to flush the market down today.  Target of 1335-1340 zone.  The bounce play that I envisioned yesterday is not playing out.  Market is definitely weaker than I expected.  Options expiration forced selling will wreak havoc on this market if we break 1345.

Low VIX Theories

It is difficult to move down 75 points in the ES in one week and still have the VIX under 18.  Even given that the end of year is usually less volatile.  But despite the correction, the market has been going down with relative calm.  Thinking through why this is, I can come up with only two theories.  1.  There aren't many weak hands left in this market.  Even with bearish headlines, there is  a lack of volatility.  2.  Traders are complacent because since 2009, every dip has been a buying opportunity and the forces who believe in BTFD and have succeeded with that strategy are numerous and tenacious and will not cave in to ordinary weakness.

If theory #1 is why the market is not volatile despite the 75 point loss since the election, then it is safe to buy.  But if its reason #2, then it is NOT safe to buy.  I am still not sure which is a bigger factor in the calm nature of the selling, but I am leaning towards reason #1 so I am fairly constructive on buying at current levels for a trade.  I usually prefer to see lots of volatility and a VIX spike before I buy but we haven't gotten it so far. 

Options Expiration Forces

You are seeing the forces of forced selling with options expiration this week.  The lower the market goes, the more that traders have to sell.  The final hour today felt like liquidation, and we will likely get a partial continuation tomorrow, but by Friday, it should be over.  The VIX is way too low here, just because its near the end of the year, no one is willing to pay up for protection.  A VIX at 18 with this kind of action is puzzling.  I am looking to buy the blood on the Streets tomorrow, with an expectation of a bounce back up to the 1380 level next week.

Can Kicking

The upcoming can kick by the politicians will make NFL kickers envious.  There will be no fiscal cliff.  Politicians only care about the short term, and getting re-elected, and even though Obama doesn't have to, he's yielded to Republican desires over and over.  That was apparent in the debt ceiling debate last year.  That is why you continue with these temporary tax cuts that always get renewed.  House members are up for re-election every 2 years, they know that a bad economy during the next two years means it will be harder for them to get re-elected.  So they will never agree to any tax increases (Republicans) or spending cuts (Democrats)!  It is the easy way out, and Obama will cave in, like he always does. 

Anyway, Washington doesn't need to be fiscally disciplined.  It has the Fed printing all the money to buy the bonds that are being issued to pay for all the tax cuts and deficit spending.  So you have yields going down despite huge budget deficits.  And the foreigners (mostly just China) park their money in US debt in order to keep their own currencies in the same crapper, fearing their exporter golden gooses will get killed with a stronger currency.  They need to buy US dollars in order to manipulate their own currencies lower, preferring to hammer their working class for the benefit of the big corporations (state owned enterprises).  Hello crony capitalism, China Style.

So a situation which should lead to clear dollar weakness only leads to slight weakness, because of competitive devaluations. If on the very low chance that we see actual fiscal discipline and a repeal of most of the tax cuts, the market will be carpet bombed in 2013. 

We have one more push lower coming soon, down to around 1360, which is buyable for a couple day trade.  

AAPL and the S&P

A company can only get so big before it saturates its market.  Unless the company turns into an unwieldy conglomerate, ala the 1960s (market cap growth but not stock price growth), you cannot have much market cap growth when it becomes as big as AAPL.  It is the law of large numbers, and it has done in numerous companies over the years.  MSFT and CSCO are the two that come to mind.  I strongly believe that AAPL has hit its all time high this year and will now be trending lower over the coming years.

Remember that the growth in the EPS of AAPL has been a huge contributor to the growth in EPS of the S&P 500.  A weakening AAPL is a bad sign for future S&P 500 EPS growth.  To understand the fundamentals of the S&P index, you have to understand AAPL.

Let's remember that AAPL is a hardware company, not a "hardware/software/cloud company".  If you don't buy AAPL's hardware, you can't use their software.  The concept of cloud is BS, it is a glorified name for internet data storage.

The history of hardware companies is littered with carcasses, especially consumer hardware companies, one being the former AAPL before the smart phone boom.  Hardware companies, especially consumer hardware companies, eventually become commoditized and gross margins shrink.  AAPL is not immune from this reality, no matter how many AAPL zealots are out there.  If you sell a product, for example an IPad or IPhone at a higher price than your competitors, when there is basically no quality difference, you are essentially trying to turn yourself into a mass luxury brand. I don't know of any luxury brand that can maintain market caps at $400B, $500B.

The reason AAPL was so popular was because its products were clearly the best out there, with competitors bringing out inferior products.  That has all changed.  Samsung and numerous others are quickly catching up, and in Samsung's case, probably already surpassing the quality of AAPL products.  Now you have the death knell of a hardware company.

1. Increasing competition bringing out equivalent or even better, cheaper products.  Gross margins get squeezed hard in the future.
2. A maturing market, with less room for growth.
3. Leadership in the company that becomes arrogant and runs out of innovation.
4. Too faddy and pervasive in the overall market. 
5. Relying on vendor subsidies to meet consumer price points.  Hard to see that continue when the products lose popularity.

AAPL is repeating history, the same way it did with the personal computer, it is doing with the smart phone and the tablet market.  It's arrogance will bite it again, as most consumers will not pay much of a premium for name brand electronics like they do with hand bags, watches, clothes, etc.  And if AAPL doesn't charge a premium, well there goes their gross margins.  Damned if you, damned if you don't.  And lastly, the IPad is a consumer toy, it has no room for serious corporate use.  Good luck trying to type a long report on an IPad.  It will never replace a laptop.

No Snapback Rallies

There was a sea change in the character of this market after the election.  Before we had a slow weakening market but now the downtrend has matured into a more volatile, top heavy market.  The rallies just don't last and we'll likely to see multiple 1 day rallies which will only lead to selloffs the next day for the rest of November.  With options expiration next Friday, I expect the market to stabilize, although likely at lower levels from here.  I still think we don't breach 1350, but now I see us trading more between 1360 and 1390, not 1370 and 1400. 

You can probably safely buy dips and sell rips for the next 2 weeks, after that I think we'll squeeze higher for good back to 1430 once the market figures out that the fiscal cliff will just end up being a fiscal can-kick. 

Close to the Bottom

I have been keeping a close eye on the SPX 1370 level, which was the 2011 high and was an important support/resistance level in the middle of the year.  We are less than 10 points away and I expect the level to hold.  We could get a slight overshoot down to 1360.  I don't expect 1325 or even 1350 to hit on this down move.  The first act of the slow motion crash in AAPL is close to completion, which means we're going to have a hard time breaking hard from this level. 

One thing that sticks out is the VIX going down on a day when we're selling off and making new lows.  The smart money is not willing to overpay for options here, meaning we're not likely to see a big move down.

It's Already Started

On CNBC, all they are talking about is fiscal cliff.  This will be repetitive for the next few weeks, and it will depress the stock market.  It is already taking away from the post-election "certainty", as if the uncertainty of the election was really holding back investors.  Anyway, expect increased volatility and lower prices for the next few weeks, as the fiscal cliff debate begins.

Election Relief

Barring a very low probability scenario of an undecided winner on Wednesday, the market should have a relief rally on the removal of uncertainty.  With a Romney win, I expect a big squeeze in stocks for the week.  With a more likely Obama win, I expect a healthy 2-3 day rally which could have us challenging the 1435-1440 level.  Any kind of relief rally should be brief because the real worry on most investor's minds is the fiscal cliff, and that will be the talk of the Street for weeks to come, putting a drag on the market even during this seasonal strong period. 

U.S.S. Crowded

This ship is taking on water.  When the obvious of US outperformance becomes so pervasive, you get money managers dumping Europe, Asia, anything but U.S.  We have pushed the limits of the US outperformance trade and the strains are now evident.  The symbols of US stock outperformance:  AAPL, GOOG, and other tech darlings have been skinned.  I am not calling for a top, just calling for a top in U.S. stock outperformance.  The fiscal cliff will bring some reduction in deficits, and that trend of increasing budget deficits will not sustain, which will pressure U.S. corporate profits.

The fiscal cliff reminds us that the sole reason for U.S. outperformance is government/monetary policy.  If you give people free money in the form of various tax cuts while adding pork stimulus, you can create a bull market.  It has nothing to do with superior companies in the U.S.  Europe didn't stimulate, and it has suffered as a consequence.  You take away the tax cuts and deficit spending, and you have Europe in America. 

Sell rallies till the words "fiscal cliff" bleeds out of your ears.

One Day Wonder

Traders have moved on past bad earnings, on to something perhaps worse.  The fiscal cliff.  The elections next week will be a nonevent unless somehow Romney wins, which will be a short squeezer.  In any case, the fiscal cliff will be the big worry after the elections and should create a volatile market. 

This year has been the least volatile since 2006.  It has sucked the life out of ES trading.  My theory about volatility is as follows:  markets are the most volatile around bottoms.  Markets are the least volatile in the stage leading up to the formation of a top, not at the top.  When forming a top and ending a bull market, the volatility rises before the downtrend.  Just based on the low volatility of this year, this bull market probably has another 6 months to 1 year left in it. 

We haven't had a rally in ages it seems.  We finally got one today.  The rally should not last for long and is a sell opportunity.  I expect weakness tomorrow.