"The capacity for hope is the most significant fact of life. It provides human beings with a sense of destination and the energy to get started." -- Norman Cousins
Hope of a fiscal cliff deal is giving the market plenty of energy this morning. There really isn't any new development in the negotiation,s but both sides are indicating willingness to compromise and that is producing a high level of market optimism. President Obama has indicated he is flexible on the highest tax rates while the Republicans have expressed willingness to produce more tax revenues. The market seems to think a deal is likely and market players are wasting no time trying to catch a celebratory bounce.
The bears are scoffing at the idea that the politicians are really going to solve this thorny issue so quickly or easily, but they are being trampled by the hopeful bulls at the moment. Action like this usually feeds on itself to some degree as shorts are forced to cover and underinvested bulls try to find additional long exposure.
The risk of chasing the market here is obvious. Not only are there very likely to be bumps in the road to a fiscal cliff agreement, but we are now heading into some significant technical overhead. If we open at current levels, the S&P 500 will be bumping into its 50-day simple moving average around 1423 and will be somewhat overbought.
Of course, the bulls have benefited from V-shaped bounces so often that they have little fear of quaint notions like low volume and overhead resistance. Once we start to run, the machines generally do a good job of keeping the momentum going and the humans have little choice but to join or be left behind.
I have to admit I'm surprised at the high level of market optimism about a fiscal cliff deal. While I fully expect a deal, I anticipated a pretty fierce battle over a number of issues. That may still occur, but it looks like neither side anticipates much political advantage in brinkmanship. People are tired of the uncertainty and want a deal even if it comes with some cost to them.
This political process is going to make for some tricky trading. The bulls are buying the proposition that a deal is close. That is quite a leap of faith given the way our politicians have typically acted in the past. It is very likely that as negotiations move into specific details, it is going to be much tougher to reach a consensus agreement.
The market is trying to look past that right now and is anticipating that it will all work out. You either buy that belief or you don't. I'm optimistic, but don't think it is going to go that smoothly.
Given that the whole focus of the market right now is on the fiscal cliff issue, it is quite easy to be caught off guard as we react to each new piece of news. Many traders are taking the approach of buying weakness and selling strength, but they were caught by surprise yesterday when the bounce kept going. The issue now is whether they will be squeezed further as optimism builds or will the bulls be trapped when political reality returns.
Faith in our politicians has seldom been rewarded for long. It is going to be interesting to see how long this market remains optimistic about their ability to find some real solutions and make a deal.