Introduction

Now that the election is over the fiscal cliff has emerged as the topic most discussed in news articles. Will we fall off the fiscal cliff on purpose, I think not. A solution is important for both sides of the political spectrum, its not something they (the politicians) can just let happen. The president will have to compromise with the republicans in the house and senate in order to achieve a solution and a compromise is what we will get. Republican Senate leaders have already revealed a willingness to accept higher taxes under certain conditions, what those may be are yet to be worked out. The solution is still cloudy and that is one thing hurting stocks at this time. Until we start to get a clearer picture of what is to come I expect more volatility.


The global economy is really what's in focus. The fiscal cliff is just one more hurdle to US, and in the bigger picture, the global recovery. The other major global players have their share of the blame to shoulder as well. Europe, the Euro zone, the ECB and all the individuals that make up the region are still in stalemate with no real solution in sight, causing their own version of the fiscal cliff to loom abroad. I have said in the past that working on the problem was enough but that may not be the case anymore. They (ECB and European leadership) know there is a problem, they know what the solution is but each time they approach an agreement one side or the other steps back. The change in Chinese leadership is another big what if on the minds of CEO's, politicians and traders. There is just no telling what plans are on the mind of the incoming leader. Speculation abounds ranging from “as is” to radical new policies to establish himself as new blood. Recent signs of growth in China have been reversed in revision and now the question of whether or not Chinese expansion is growing is again on the table.

The positive, if somewhat lackluster, signs I have been seeing in the US data may not be enough to support stock prices, especially if Europe and China slide again. Weak growth and consumer spending around the world could negatively impact revenues despite improved operating margins. Even with the improved margins reported by so many companies this quarter a decline in revenue will not bode well for earnings growth.

With so many factors in play it is no wonder the markets are showing so much indecision. A time of change is upon us and the next few days could determine the underlying direction of the equities markets.

The Economy

Today's round of economic data failed to boost stock futures. A surprising drop in initial claims for unemployment was met with skepticism in the wake of the recent and ensuing storms in the northeast. I think everyone concerned is awaiting a spike in claims related to the storm but so far no surge has materialized. Next weeks, and the next, will likely show some wild fluctuations as storm displaced workers filter into the system. This week initial claims dropped by 8,000 claims to 355,000, the second lowest initial number in over 3 months. The expectations were for a gain of 7,000 from last weeks unrevised 363,000. The four week moving average climbed though, and reached a new short term peak.


Continuing claims and total claims move opposite each other. Continuing claims fell by 135,000 to 3.127 million, the lowest level since July 2008, while at the same time total claims for unemployment rose to a three week high. The sharp drop in continuing claims is a potentially positive sign for job creation and hiring but could also be influenced by storm victims failing to make it in to file claims. Total claims, though on the rise in recent weeks, is still at multi-year lows.



The trade balance was also released today. The trade balance shrank to $41.5 billion from August's revises $43.8 billion. Exports hit a record high, rising 3.1% in this months data, helping reduce the imbalance in imports and exports.

Around The World

Mario Draghi made some more statements today reiterating those yesterday. He says that Europe is weaker and weakening but that confidence in the financial markets is on the rise. He, and the ECB, have decided to hold interests rates steady in anticipation of Spanish requett for OMT bail out assistance. Spain is still holding off on asking for the funding but the fear is that the funding may disappear before Spain finally decides to take the help.

Greece's stonewalling and back pedaling should have ended today with the approval of their austerity plan but now Germany is telling them that they and the ECB were not yet ready to give the money. Greece is expected to need the money as soon as next week but that is “too soon” according to the German finance minister. Spain may need to take a cue from this twist because the bailout rug could be pulled from under its feet as well. All in all, Draghi and the ECB have lowered outlooks for growth and now predict a 2013 recession that could extend and worsen into 2014. This scenario, which looks more and more likely, is not good for world or US GDP growth.

Asian shares dropped following our sell-off. Drops of 1.5-2.5% occurred in Asian markets around the region. There are a number of factors in play here including our election and subsequent market sell-off. One is the Japanese economy. The Japanese are still struggling with growth and already have further stimulus on the table. The BOJ injected money a few weeks ago and the move was met with criticisms of inadequacy. Another is China's change in leadership. China's change in leadership leaves the door open to a lot of questions concerning business and financial policy for that country and its international partners. European recession also looms over China, one of China's largest trading partners.

The global scene is in turmoil. Things are changing and no one really knows how it is all going to play out. Draghi's comments about a 2013-14 recession and the possibilities of our own fiscal cliff put my short term outlook at risk. I have been expecting an uptick in GDP for the fourth quarter. Now it's possible my fourth quarter uptick theory may have gotten steamrolled by the longer term outlook. I'll be watching the news like a hawk for signs of strengths and weaknesses abroad.

Gold And Oil

Gold climbed amidst all the global transitioning. Possible stimulus in Europe, possible stimulus in Japan and a continuation of loose fiscal policy at home could increase bullishness in gold. The metal climbed back above $1700 to hit an intra-day around $1725. Higher gold prices translated to higher prices for gold miners and the gold index. The Gold Index gained about a quarter percent today, continuing its bounce from support started earlier this week. The index is now moving up from the long and short term EMA's. Higher prices for gold, even in the short term, will help boost profits for gold miners.

The Gold Index, daily

Oil prices held steady through the day as oil traders tried to assimilate all the information. The oil markets have a lot to consider. Global oil demand growth is already tepid and now current events are dictating uncertainty for the foreseeable future. The oil index dropped in value yesterday and today, negating its head-fake break above resistance earlier in the week. The index is now back below the longer 150 day EMA and heading down but faces possible support building around 1200. Oil itself has been trading around $85-$86 for over two weeks, and could be forming its own support base at that level.

The Oil Index, daily

Story Stocks

McDonald's made headlines early today. The fast food giant reported that October same store sales fell around the world. Blame was laid at the feet of dollar menu values and other deals which the company said it was seeking to remedy. Shares of McDonald's continued their down trend and hit a new 12 month low today.

McDonald's, daily

Natural foods retailer Whole Foods Market beat Wall Street estimates with its earnings. The company also raised the dividend and restated 2013 profits estimates. The guidance is below consensus estimates and sent the stock down by more than 2%.

Whole Foods Market, daily

Duke Energy reported profits that also beat estimates. This was the company's first reporting season after its merger with Progress Energy and results were mixed. Earnings beat on an adjusted basis while revenue fell short, a theme not uncommon this quarter. Duke also reaffirmed full year guidance in a range bracketing the consensus estimate. Shares of Duke opened higher but then sold off during the day. Duke is trading just above a possible support level and bears close watching. The stock is a favorite among dividend investors and becomes more and more attractive the cheaper it gets. Duke yields about 4.85% at the current prices.

Duke Energy, daily

JP Morgan continues to recover from the London Whale. The bank won the right to begin its stock repurchasing program today. The approval gives JPM the OK to buy back up to $3 billion in stock during the first quarter. Shares responded by opening higher but negative pressure won out on the day. The stock is currently above a significant support level, one that just happens to be coincident with the window opened upon the announcement of the Whale.

JP Morgan, daily

Qualcomm posted impressive earnings. The company improved fourth quarter EPS by more than 20%, beating estimates by a nickel. The chipmaker also upped its guidance to a range above the consensus estimate. Cited in the report were strong sales of chips for smart phones and tablets. The stock gapped up strongly at the open but fell on heavy volume from there. $60 could emerge as a significant pivot point for this stock.

Qualcomm, daily

The Indexes

My longer term outlook is changing, my previous targets for the index to retest four year and all time highs has shifted. Yesterday's trading produced a long black candle that confirmed a triple top. The top may prove to be short term in nature but I see the markets moving down before they move up again. The S&P is moving into oversold territory but if this is an extended down turn in stock prices the index could remain oversold indefinately. The MACD is bearish and showing an increase in momentum, though the levels are still well below the 12 month peak. Today's selling took the index below the 150 day EMA and broke the last support line I have at this level, 1380. 1380 is the 78.6 retracement of the 2008 and the lower end of the resistance range created by the peaks of 2008.

S&P 500, daily closing

S&P 500, daily with Stochastic

In the longer term, looking at charts of weekly closings, momentum has turned bearish as well. The momentum is very weak at this time but has not rolled over so bearish momentum could still be increasing. The declines have not yet broken, or even reached, the long term up trend line I have drawn from the 2009 bottom so I will be watching this line very closely as price approaches it. When I draw fibonacci fans on this chart the middle fan matches up exactly with this same trend line. I would expect prices to bounce up from this line or give signals of impending weakness. This trend line will be my next downside target now that the index has dropped below 1380. This drop could take the S&P as low as 1350-1325. On the positive side, stochastics shows underlying long term strength in the index. The successively higher bottoms as the market rallied over the last two years suggests that there are buyers waiting to buy stocks as they approach the up trend line.

S&P 500, weekly closings

The markets are all wound up. Data, election, earnings, fiscal cliff, global growth and capital preservation have traders and investors preserving capital until the dust settles. It is possible that the S&P is in a trading range and that it may bottom soon and then move back up. It is also possible that the recent volatility and topping action is the precursor to a period of extended selling or at the very least very choppy trading. Solutions to the fiscal cliff include higher taxes, probably on capital gains, dividends and other forms of passive income, so selling now could be a money saver for those who were planning on selling in next year or two anyway.

The argument that people are selling stocks now, and presumably into the end of the year, in order escape higher capital gains taxes next year leads me to think that maybe next year people will not be selling stocks. If no one is selling stocks next year then stock prices could rise simply on the natural and regular buying of institutional and personal investors. If that is the case then now and the next few weeks could be a great buying time for the long term investor. If a solution arises that puts aside fears of taxes being raised in unpopular and arguably unfair ways it could spark a rebound in stocks, especially dividend payers. Its a lot of ifs I know but if I knew the answers I would be a very rich man.

The Dow has moved below its critical support and long term moving average. Despite the sharp drop over the last two days there signs here that the selling may be nearing an end. The MACD is divergent just like the S&P; the possibility of it increasing is also here. The stochastics is also showing some sign of the possibility of this round of selling being short lived. This indicator is very low in the range, deep in oversold territory, and turning up. Every time in the last three years that the stochastic indicator for the Dow Jones Index chart of daily closings has reached an oversold extreme and turned up a rally has followed within weeks (of course you know that now I have put that in writing the exact opposite is likely to happen).

Dow Index, daily closings

I expect more selling tomorrow. Without a strong catalyst the flight from the possibility of higher taxes is going to send stocks lower. The next few days, especially going into Monday, could bring more volatility to the markets as technical levels are breached. The VIX actually moved down today, counter to the up movement I usually see on down days, suggesting to me that options traders were selling options and capturing premium. Taxes on options selling will be affected as well so traders may seek to get as much option money out of the markets they can.

The VIX, daily closings

Needless to say there is a lot going on in the world today. Major shifts are occurring in leadership, financial policy and possibly the very nature of the world economy. The markets finally decided to stop and check out the changes, now we have to wait and see what they are.

Until then trade conservatively and stick to your trading rules.

Thomas Hughes