The Day Ahead: Destructive Complacency

 | Dec 17, 2012 | 8:00 AM EST  | Comments
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If anyone who comes up to you this week and says traders and investors are leaving for holiday vacation, and that there isn't much doing, simply laugh in their face. If you happen to read that trading floors are ghost towns, ignore the statement. The real deal is that, in a world of smartphones and online brokerages, you'd best believe that a sea of sell orders will flood the market if things get ugly.

That said, here's what comes about if folks believe five full trading days will be meaningless due to the impending Christmas holiday: complacency. There is such a wait-and-see attitude out there that, if it's left to fester -- and it will -- it will become very possible to chip away at the market's gains from mid-November (last Thursday short-term peak). We are all fully aware of why complacency exists; folks are waiting for resolution on the fiscal cliff. But you must know what I'm talking about.

The Great Search for Complacency

To those wearing the gorilla costume and pounding the table on stocks -- a call derived from irrationality -- allow me to present these three wonderful charts in support of my ongoing bearish market call. First, there is the Russell 1000 Index. I don't really care if the index is only down 0.8% since Dec. 10 (bulls love their relative comparisons). The fact is that this reeks of the type of complacency that deserves to be wrung from these stocks' valuations as fiscal-cliff drama continues to mount.

Russell 1000

Why does complacency in this index bother me? Well, spy the reads in the railroad and consumer-discretionary stocks, obviously both U.S.-centric and very leading-indicator-ish.  Both of these indices also display complacency; in other words, they confirm that the overall market has not properly discounted the economic effects of fiscal cliff. If stocks aren't properly discounted, it means a risk that we'll see further drainage of the bullish sentiment that has fueled the market since the mid-November lows.

Note: Since Dec. 10, the S&P Railroad Index has fallen 0.8% and the S&P Consumer Discretionary Index has sunk 0.5%.

S&P Railroad Index

S&P Consume Discretionary Index

Complacency Plus Nervous Investors Equals What?

I hate to be the bearer of bad news, but when we see complacency on a large event with uncertain outcomes -- all currently poised to be negative ones -- there is risk as to how fresh news will be interpreted. For example, in this case, I am concerned about fiscal-cliff resolution with increasingly a combative tone, and I've responded to the Fed's latest actions with a big yawn, to say the least. On top of this, a few reports ahead may add to this level of angst.

Empire State/Philadelphia Fed Surveys: The market has shown a less-than-favorable response to housing data -- at this point, it almost expects the number to be positive. But it is really locked and loaded on manufacturing and consumer spending reads -- and, in this regard, the recovery mystique that once circled these macroeconomic stories has receded into the background. Both the Empire State and Philly Fed have the potential to be a double-whammy of negativity, in the form of renewed weakness in new orders and persistent limpness in employment. That's prior to the onset of fiscal cliff, which will spur recession talk for the first half 2013.

FedEx (FDX): I don't think the company will come in near the low end of its quarterly earnings guidance and issue another material warning for its fiscal year -- and normally, when this sixth sense of mine kicks into gear, I suggest buying the stock into the print. Alas, in this case we're dealing with the long shadow of the fiscal cliff, and with it comes a feeling that U.S. package volume may get uglier in the event that there's no year-end deal -- or that we'll see something highly subpar. (U.S. package volume was down 5% in the prior quarter.)

This is a great example of the wait-and-see mindset currently dominating the market -- a lack of trust in indications of trough earnings. I have more comfort in playing my 2013 pick, Nike (NKE), into that company's report. For Nike, the China recovery is mopping up excess inventory; it's coming into a strong U.S. footwear cycle; and price increases are offsetting manufacturing-cost inflation.

Risk-reward scenario: It's even more unsavory than what I detailed last week. I'm having nightmares about those long nights from the summer of 2011, when the debt ceiling debates were ongoing.

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