Fiscal Cliffhanger

 | Dec 31, 2012 | 8:13 AM EST
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Politics: "Poli" a Latin word meaning "many;" and "tics" meaning "bloodsucking creatures." --Robin Williams

It is rather fitting that 2012 trading concludes totally focused on the political debate in Washington. The most notable theme in this market over the past year has been action driven almost completely by central bankers and politicians. Fundamentals and stock picking matter little. The driving forces have been news headlines and printing presses.

The year started with a massive rally that was primarily a function of the Fed's quantitative easing program. In the last version of quantitative easing, the Fed bought mortgage bonds and that drove the market up for nearly three months.

As that liquidity was digested, the focus shifted to Europe and jerked back and forth over various European agreements and bailouts as the European Union struggled to deal with its sovereign debt problems. Greece was "saved" at least a dozen times and the Europeans did well by following the lessons of Ben Bernanke and his liquidity machine.

The presidential election was the source of speculation for months and the squabbling in Washington drove the market back and forth, but overall the willingness of central bankers to provide endless liquidity kept this market running.

It is only fitting that we conclude this year of government-driven action with the ridiculous fiscal-cliff debate. Many market players were optimistic that our political leaders would actually put aside their differences and manage some sort of compromise to avoid the tax increases and spending cuts that hit tomorrow, but they were wrong. The dysfunction in Washington is truly staggering and the market is grappling with it this morning.

The bears have warned for a long time that sooner or later we will face a day of reckoning. The Fed could only prop us up for so long before we have to face the reality of a growing deficit and the refusal to cut spending. Many pessimists are convinced that this fiscal-cliff debate is the beginning of what will be a very difficult period for the market. It has run up for nearly four years primarily due to liquidity rather than fundamentals, and now the worry is that we will have to deal with very hard issues that have been ignored for a long time.

More about the long-term picture later; right now, the short term is all about the fiscal cliff, and the market is acting as if it is not expecting a major deal today. The politicians are working at it but, at best, the likelihood is a short-term bandage that will push the debate down the road a little ways. No matter what happens, we still face the debt ceiling and this whole issue once again in a few months.

Even for those who follow the market and the political debate closely, this chaos is almost untradeable. All movement depends on the next headline, which is like placing a bet on each spin of a slot machine. Individual stock picking is mostly irrelevant as stocks are highly correlated and will move as a group, depending on the news.

My inclination is to nibble at a few little things in preparation of a bounce but on a very limited basis. There should be time to catch a relief rally once we finally move beyond this fiscal cliff, but the potential for even more downside in the near term is too high to justify loading up at this point.

Have a watch list ready and be mentally prepared to move as the news flow hits. We are very likely to see headlines soon that will move the market quickly.

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