SPX Could Hit New Reaction Highs if Fiscal Cliff Is Resolved

By Jeff Saut  NOV 26, 2012 10:10 AM

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From Richard Fisher (President of the Dallas Federal Reserve):

Just recently, in a hearing before the Senate, your senator and my Harvard classmate, Chuck Schumer, told Chairman Bernanke, "You are the only game in town."  I thought the chairman showed admirable restraint in his response.  I would have immediately answered, "No, senator, you and your colleagues, Democrat and Republican alike, have encumbered our nation with debt, sold our children down the river and sorely failed our nation.  Sober up.  Get your act together.  Illegitimum non carborundum; get on with it.  Sacrifice your political ambition for the good of our country – for the good of our children and grandchildren.  For unless you do so, all the monetary policy accommodation the Federal Reserve can muster will be for naught."
In my opinion Richard Fisher said in plain English what Ben Bernanke is trying to say in a much more politically correct way – hey Congress, get your act together because I have done just about all I can do on a monetary basis, so it is up to y’all to make the tough decisions on fiscal policy that need to be made to get this economy going again.  

Surprisingly, I think Congress, and the president, will rise to the occasion because if they don’t, and the country falls off the “fiscal cliff” for an extended period of time, it most assuredly will put us back into a recession.  To be sure, it is kiss and tell time inside the DC Beltway, and in my 42 years in this business, when something absolutely had to happen it has typically happened. 

For example, in October 1974 Franklin National collapsed for the largest bank failure in US history, in May of 1974 New York City was insolvent, September 1979 saw the dollar implode, in January 1980 inflation soared to 18.1% with short-term interest rates spiking to more than 20%, the October 1987 “crash,” in August of 1990 Iraq invaded Kuwait, the summer of 1998’s Russian default and subsequent Long Term Capital Management meltdown, not to forget the Enron/ WorldCom debacle – GM’s (NYSE:GM) bankruptcy – the Flash Crash – the downgrading of US credit rating, well you get the idea.  And after each one of those crises the economy, and the stock market, survived and then prospered.  I think it will play that way this time as well.

For that opinion I was called a “cockeyed optimist” by a number of portfolio managers during my recent European speaking tour.  I responded by noting that if you study history you find numerous periods of political acrimony where nothing gets done – and we’ve had that.  Now that the election is over I think a fair amount will be done to tackle the debt situation and increase the productivity of government.  Moreover, I believe the fiscal cliff will be avoided; or if not, “the cliff” will only last for a few days.  That belief is centered on what I wrote in last Monday’s missive.  To wit:

President Obama was beaten up pretty good in the debates, which looks to have made him more flexible, at least to me.  Moreover, if you read his book you come to understand that not only does he want to leave a legacy, like every president, he wants to leave the image of the greatest president ever!  Given that, and the fact the Republicans got crushed in the Electoral College, my sense is that both parties will be more flexible going forward.  Accordingly, I think President Obama will make some major policy breakthroughs despite the usual Washington Waltz rhetoric.

And last week some “absolutely had to happen” events happened, or at least appear to be close to happening.  In the “happened” column was the cease-fire between Hamas and Israel, which as of this morning seems to be holding.  In the “close to happening” column is that Greece looks to be on the verge of more financial aid from the eurozone, while in this country I am hearing there are some high-level discussions going on about how to avoid the “fiscal cliff.”  Certainly the stock market is “hearing” something given the S&P 500's (INDEXSP:.INX) 4.9% sprint from its intraday upside reversal low of 1343.35, that occurred on November 16, into last Friday’s closing bell.  At the time the NYSE McClellan Oscillator was deeply oversold, suggesting a near-term rally was likely at hand, and boy did we get one. Regrettably, the five-day rally has left the McClellan Oscillator back in overbought territory, causing many market mavens to opine that all we have seen is a throwback rally with more downside to come.  While it is hazardous to ascribe much meaning to market movements during holiday-shortened weeks, the fact that the SPX has vaulted above my 1390 “energy level,” as well as travel back above its 200-day moving average at 1383.24, should be viewed as constructive.  That’s why last Wednesday I wrote:

The 1390 level on the SPX has proven time and again to be a key ‘energy level,’ both on the downside and now on the upside for the markets, as can be seen in the attendant chart.  Moreover, as seen in the shaded levels in said chart, ALL of the recent tradable rallies have begun with a ‘long-tailed’ green upside candlestick chart formation.  That ‘green candlestick’ upside move occurred [last] Monday (Dow (INDEXDJX:.DJI) +207-points), after Friday’s upside reversal for the SPX, on heavy volume, potentially signaling the fabled year-end rally is near.  Moreover, all recent rallies have come when the Dollar Index has been near a peak, as it is now near last January’s peak of 81, followed by dollar’s subsequent decline.  So, while the media is rampant with ‘fiscal cliff’ worries, I think the year-end rally is near, or has actually begun.  At worst, I believe last Friday’s intraday “low” (1343 basis the SPX) and should be traded against as a failsafe point looking for higher prices.  While that level may yet be retested, I think it will hold into the New Year.

Obviously I still feel that way, and would note that even though it took longer than it should, the recent undercut low chart pattern often referenced in these reports has gained more credibility given last week’s surge.  The trick from here will be to rally above the 1420-1430 zone that was a support level on the way down and now becomes an overhead resistance area.  The current short-term overbought condition implies the SPX probably won’t make it through on its first try, but if the “fiscal cliff” looks as if it will be resolved I think the SPX will make new reaction highs.

As for how to play this potential scenario, a few of the triple plays (beat earnings and revenue estimates and guided forward earnings estimates up) that occurred while I was away, and are favorably rated by our fundamental analysts with concurrent attractive chart patterns, include: DigitalGlobe (NYSE:DGI); Extra Space Storage (NYSE:EXR); FleetCor (NYSE:FLT); and Qualcomm (NASDAQ:QCOM). Other special situations that play to some of my themes are: Alere (NYSE:ALR); Covanta (NYSE:CVA); DaVita (NYSE:DVA); Kansas City Southern (NYSE:KSU); and Rayonier (NYSE:RYN).

The call for this week:  All of the recent tradable rallies have begun with a “long-tailed” green upside candlestick chart formation (see shaded areas in chart below).

Click to enlarge

That “green candlestick” upside move occurred last Monday (INDU +207-points) following the previous session’s upside reversal on heavy volume, potentially signaling the fabled year-end rally is near.  That view is supported by the upside breakaway “gap” seen in the ProShares Ultra S&P 500 ETF (NYSEARCA:SSO) (see the chart below).  But, this morning it looks like the overbought condition will take center stage, at least early, with the pre-opening futures down about 7 points as I write this.

Click to enlarge
No positions in stocks mentioned.

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