The Day Ahead: A Bizarro-World Market

 | Dec 12, 2012 | 8:30 AM EST
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Do yourself a solid today and follow my lead -- and look at these currently popular investment themes -- ones that have seemingly flown to me from Mars:

● A well-detailed "fiscal cliff" deal is in the cards in two weeks' time. It will be a great holiday gift to families giving presents funded with money taxed at lower rates.

● Smart money is fearful of being underinvested into an impending fiscal-cliff deal, and is willing to absorb a hypothetical future beating should December offer no political love fest.

● Balance-sheet expansion by the Federal Reserve, which is the complete opposite of Operation Twist, will indeed wipe away any prospects of a first half 2013 "cliff"-borne recession. (You know, a cliff deal does mean fundamental changes to the economy -- but who cares, right?)

● No outward war of words in Washington means behind-the-scenes progress that will lead to a grand announcement on the Friday or Sunday before Christmas, planned so that both parties can talk about how they saved the world from imminent disaster.

Then, at this juncture, is where things will become super fun. Über-bullishness feeds directly into how data points and corporate news are interpreted. Note that, given comments from Texas Instruments (TXN), DuPont (DD) and Cummins (CMI), I do believe early indications of fourth-quarter earnings estimates -- which have been sliced since October -- are too pessimistic. But I keep returning to whether any of this is relevant in a newly constructed U.S. age of austerity, and a European Union that is not as structurally tame as peripheral bond yields would suggest. Now consider the following.

● Cummins and DuPont apparently believe a wise use of shareholder dollars is shelling out $1 billion on share-repurchases to pad earnings growth (and executive year-end bonuses), rather than using it toward a transformative acquisition or material investment boost in capital expenditures. Why am I upset? Well, isn't fiscal-cliff certainty supposed to unlock a renewal in long-term fixed investment? Nonetheless, the Street has modeled for very little in the way of a share-repurchase cushion from companies, as analysts have been overly focused on special dividends. So, in the near-term, the market has another reason to fly around in la-la land.

● DuPont's guidance comments fit squarely with those of Texas Instruments: A worst-case scenario did not materialize in the fourth quarter -- and, in fact, this underscores the hidden earnings power of companies in a low-growth environment. Imagine if we see a modest U.S. economic upswing in 2013 vs. 2012. Again, I'm talking market perception here -- we really have to be careful on thinking any of this stuff will unfold in line with current market expectations.

● Key areas of the market appear oh-so-alluring. The Philadelphia Semiconductor Index (SOX) shrugged off the Texas Instruments mediocrity; oil rose; and comments from the short-term sheriff, Senate Majority Leader Harry Reid (D-Nev.), went ignored. Everything is working on the surface, right? Not necessarily. If everything had been so wonderful, I venture that railroads and specialty apparel stocks would have been higher Tuesday amid the drugged-up sentiment.

Personally, I think this total air of invincibility in the market is despicable. I fully understand how the mythical "wall of worry" operates; stocks will climb it until the actual worry smacks investors in the face. We are experiencing a true wall-of-worry move in stocks, predicated on irrational expectations of a fiscal-cliff deal and utter ignorance on the nitty-gritty aspects of new fiscal policy that will permeate real life. In turn, that reality will feed back into corporate earnings in 2013, or so one would think in any sane investing backdrop -- one not based in speculation.

I continue to advise high selectivity on stocks, or to sit on the sidelines entirely. Believe me, when a fiscal cliff deal is delivered, there is unlikely to be an immediate sell-the-news moment. In my opinion, a deal will bring out the ability of Mr. Market to properly dish out multiples and projected future earnings assumptions, and that adjustment process is not being reflected today.

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