The President is on his way to Washington, Congress is back today and all are looking for a simple solution to the problem that has been facing them for more than a year. If it wasn’t simple enough to solve over the last year… how will they resolve it over the next four days? I know I am be too practical and logical on the issue, but in the end some deal is likely to be struck to kick the can down the road. The solution today seems to be with the Senate coming up with 7 republican votes to pass a simplified bill to avoid the cliff. I love the posturing and grappling with this issue as if something will be done worthwhile. Regardless the issue for us is how does it impact the markets as we head into a new year? Answer… poorly initially if the cliff issue isn’t avoided. The current levels have not priced in higher taxes across the board. Thus, the downside reaction from here would be substantial. Between now and Monday someone has to find a solution or down we go.
How far is the drop? That is anyone’s guess as it depends on the time it would take to deal with any future changes in the laws, tax structure and who it all impacts. In other words we will put a completely different spin of uncertainty on the markets and that takes time to work through. I will leave it at the fact there will be plenty of volatility in the markets to deal with.
Speaking of volatility, the VIX index has moved above 19 putting it in play relative to the downside for stocks. The 21 level would be the next key level to break on the upside and could start further downside movement in stocks short term. VXN index for the NASDAQ is at 21.75 and pushing through key resistance showing increased volatility in the index as well. These are a result of the cliff talks primarily, and if today doesn’t show some positive signs this could move higher showing more volatility or downside risk for stocks.
Thus, the downside plays are gaining some momentum. A look at SH, ProShares Short S&P 500 Index ETF you can see the bounce off the recent lows and a push through the resistance at $34.25. Equally the bounce in PSQ, ProShares Short QQQ ETF is breaking above resistance at $26. Both are responding to the downside pressure from the current uncertainty in the broad markets from the budget issues. I am not making a statement relative to the downside, but simply noting what the charts are stating what investors are doing. Much of this activity is hedging currently, but I would expect some speculation to jump in as we approach the deadline without a resolution in hand.
All of this cliff dodging and talking has left out the normal speculation on what is going to be the winning stock or sector for 2013 off the radar (thank goodness). First things first! We have to get through this problem before we can address all the ones that are causing the root of the bigger problems. Confusing… yes, but what do you expect when Washington is involved in the process. We continue to be extremely cautious currently and look for the downside risk to continue building without a solution. The trades associated with the move are equally speculative unless you are hedging your existing portfolio. Be disciplined in your approach to this issue as we slowly work towards the end of the year.