The Day Ahead: No Holiday Cheer Here

 | Dec 24, 2012 | 8:00 AM EST  | Comments
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Are you in the holiday spirit? Sucking down an ice-cold seasonal beer for breakfast, are you? After all, the market does close early Monday. That's great, fine and truly glorious. But, while you rock those fun holiday activities, I am here to spoil the tomfoolery and suggest a pure hardcore focus on protecting your online brokerage account balance.

The stock market gave us valuable clues Friday, many of which are being swept under the rug due to that session's "late charge" into the closing bell. This leaves the market in a complacent state of mind. So does the fact that permabulls remain in love with month-on-month data trends that are far removed from economic reality and relevance, given the fiscal cliff.

With this excessive complacency come loads of investors, both large and small, who are not properly hedged against short- and longer-term risk factors. The definition of "hedge" has two basic forms. It could be a complete move to the sidelines in cash so as to protect hard-won year-to-date profits -- which has been my advice for a little over two weeks, in tandem with a short recommendation on General Electric (GE). Or, if one is unable to cut bait from core positions, the other choice is put options underneath those holdings, or short trades on worst-in-show companies that are in the same industry as that of one's primary holdings.

What I Saw in the Markets on Friday

In the last trading session, indices fell around the world, indicating the U.S. is the straw that truly stirs the drink. To me this says that, if the U.S. does enter into a cliff-induced recession (likely translating into sub-1% gross domestic product growth in the first half), the nascent China economic recovery could stall by the end of the first quarter of 2013. China remains very export-driven, even despite the government's efforts to promote consumption -- and if the China crutch goes, so does the bid under many industrials, among other sectors.

Yes, the S&P 500 shaved Friday's losses into the close. But, in my view, this was based on optimism that a place-marker cliff deal was set to emerge this past weekend -- a pre-Christmas gift to the world from Washington politicians.

Overall, what's being communicated by Mr. Market is that the data is altogether backward-looking and irrelevant -- and that, because of the fiscal cliff, these numbers have no chance of strengthening or even being sustained into the first quarter. Earnings estimates, therefore, are too high.

One last note on Friday's action: The Nasdaq outperformed the Dow by 1.3% last week, largely as a function of Apple (AAPL). I've snooped around a bit, and I believe the other underlying components of the index may show caution on any impending first-half revival in material capital-expenditure spending -- which I would hope will emerge as more of a slow build. It makes one wonder if, for instance, Oracle (ORCL) was too optimistic with its commentary, and I also wonder how less fortunate companies will fare in six months' time. 

Washington Is Not Baked In

Have you picked up on what I am suggesting? Ahead of year-end, the equities market does indeed have a better-than-average chance of suffering a more perilous session than what we saw Friday. The way I figure it, stock valuations are not factoring in Washington's series of unfortunate events, so valuations are still reflect misguided optimism.

First, a "thumb-in-dike" cliff deal -- one that temporarily mitigates enormous pain levied on consumers -- will only ratchet consumer angst higher. That is, uncertainty will not vanish for sure. Moreover, such a deal would fail to address the gripes of CEOs that we've been hearing since the middle of the year.

Second, there is no promise that a "thumb-in-dike" deal will be inked. If that is left to happen, markets are likely to really sink this week -- and, in that case, this past Friday will probably be seen as the overlooked start of such action.

Finally, a "thumb-in-dike" deal would open the door to a harsher set of legislation. That would raise the probability for a recession that won't show in the macroeconomic numbers until the second half of 2013, but which will stock prices will begin to reflect in the first half.

Unfortunately I see that analyzing companies, as I was taught to do, remains on the back burner. One must filter every 2013 guidance range through the strainer known as the "fiscal cliff." Same goes for every income statement, balance sheet and risk-factor section in a 10-K filing with the SEC. Obviously I am very bothered that I need to prepare in this capacity. However, at least I am able to rest comfortably at night, knowing folks are not positioned to lose their shirts, even if it means missing a one-day rally that seems to constitute the start of the next raging bull market.

In a word, I remain bearish.

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