Watch for Signs of Nervousness

 | Dec 19, 2012 | 8:21 AM EST
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The best way to make a good deal is to have the ability to walk away from it. --Brian Koslow

The market continues to chug higher as optimism about a fiscal cliff deal builds. The fear of missing out on a market rally when a deal is announced is sucking in more and more buyers. Although the politicians are making some pessimistic comments in public, the fact that both sides have already compromised to some degree creates the impression that they want a deal.

Rating agency Fitch is putting a little additional pressure on the politicians by putting out a note stating that it would likely cut the U.S.'s AAA bond status if no deal is made to stop the $600 billion in spending cuts and tax hikes. Fitch fears that it will push the economy into a recession. When the ratings agencies opine that austerity measures are a negative and will cause a debt downgrade, there sure isn't much motivation for the politicians to worry about spending.  

The pressures to make a deal are tremendous and the market is acting like it is inevitable. There just isn't much else to do right now but to embrace that assumption and enjoy the ride. Once the deal is out, the market action is going to get very tricky very quickly.

The bulls are hopeful that a fiscal cliff deal is going to be the catalyst that puts this market into a sustained uptrend. The thinking is that we will finally put this major uncertainty behind us and with the economy show some feeble signs of recovery it will be clear sailing.

The bears' response is that the market is overlooking a slew of negatives as it focuses on the fiscal cliff issue. Once that deal is done, the market will realize that it has to contend with a poor economy, weak corporate growth and a Fed that is running out of ammunition.

The bears are ready for a major 'sell the news' opportunity once the fiscal cliff deal is done and the more frothy the market action is in front of the news, the more aggressive they will be in selling it when it hits. Further complicating matters is that we are at the end of the year when tax selling and portfolio adjustments are occurring as well. Once we have some clarity on tax law changes (as far as dividends and capital gains), that will likely drive some last-minute market movement.

What we have to watch for right now is some nervousness as the deadline for a deal approaches. It is still a few days away, so no one is going to panic over negative comments right now. However, the closer we get to the deadline, the more those comments will matter -- especially if they come from key players. The Wall Street Journal Op-Ed page this morning is arguing that it is better to go over the cliff than to take a bad deal. The closer we move to the deadline, the more the market will worry about that actually occurring.

For now, all that matters is that the market is optimistic about a deal, but we have to stay extra vigilant and watch for signs of nervousness or doubt. The potential for an ugly downside spike is high if the negotiations start to unravel, but the politicians are acting like they want to get this done and that is keeping the market happy.

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