One Great Certainty

 | Jan 03, 2013 | 8:10 AM EST
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Change is the law of life. And those who look only to the past or present are certain to miss the future. -- John F. Kennedy

While the big move to start the new year caused celebration among investors, it also produced consternation among traders who were caught by surprise. The uncertainty of the fiscal cliff and the fact that it was the end of the year had pushed many market players into cash, which produced additional chasing when the market exploded higher yesterday. Nothing is worse than starting the year with substantial underperformance.

It was a very interesting day of action but the only question that really matters is where do we go from here.

Over the last couple of years, the market has had a strong tendency to build on momentum of the sort we saw yesterday. Last January through March is a particularly good example. There was a similar jump on the first trading day of the year in 2012 and the market went up in a remarkably straight fashion for months after that. What was particularly interesting about the move was that there were almost no pullbacks for weeks. It just ramped higher and caused tremendous frustration for underinvested bulls who never had an opportunity to put money to work and for the poor bears who deluded themselves into thinking they could call a market top.

Moves like that have been more common since the market low in March 2009. There have been two reasons for that. First, the Fed's quantitative easing programs created a flood of liquidity that had few places to go but into equities. It had to be put to work and the easiest thing to do was to throw it at stocks in general. There was little effort to be selective in stock picking as everything pretty much moved together anyway.

The second reason this lopsided action often occurred was that computerized trading programs made an effort to exploit this market tendency. Since it was obvious that market players were not well positioned and that shorts were vulnerable, they would keep pushing and create perpetuate squeezes.

That brings us to the question of whether these two forces still exist to the same degree and will push the market straight up once again. While the Fed is still buying nearly a trillion dollars a year in bonds, there is no new QE program being initiated and the market no longer looks to the Fed in the manner it once did. The fiscal-cliff debate illustrates how the focus is shifting to taxes and spending, which are not affected by the Fed's monetary policy. The next big battle will be the debt ceiling and that is going to be a major catalyst.

The computers will still be out there, but the way they survive and prosper is to adapt to new conditions. They did well exploiting lopsided momentum but the likelihood is that they will start to focus on volatility strategies as QE becomes less relevant. That would give us more sudden ups and downs; that, from my perspective, would be better for traders, but the key to computerized trading is to do what the market least expects.

Overall, I believe that without the Fed's QE program we are less likely to see strong sustained momentum. I'm not going to rush to fade strength but I'll be more inclined to take profits quickly and look for new entries once things setup again.

The one great certainty in the stock market is that things always change and my thesis for 2012 is that the Fed will no longer be the dominating force that it has been.

It's a very mild start this morning. There are some bank upgrades and analysts are busy, but the mood is calm as market players anticipate the challenges of the year ahead.

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