Every once in a while (of late, more accurately referred to as “daily”), my wife reminds me of the need to be “optimistic” and “objective” when trouble looms.  So once again, let me “give it another (albeit perfunctory) try.”

OK, here goes:

Thanksgiving 8 days away.  Check.

Christmas 40 days away.  Check.

Financial Armageddon 47 days away.  Hmmmm.

Hey Honey, does “two out of three ain’t bad” work in this case?

Now if reports are accurate (and now that the election is over, some actual news beyond just the latest highly inaccurate poll data is once again beginning to trickle out) on January 1^st the United States of America will transform overnight from being the most indebted country in the history of the planet to the being most indebted country in the history of the planet but with sharply higher tax rates and a sharply reduced national defense (Wow, coupled with a hangover this could be serious). 

And believe it or not, it gets worse.  For the reality is that the only things standing between us and our prescheduled doom are the very people who scheduled Financial Armageddon in the first place by kicking the can down the road so as to have to deal with the problems now instead of back then.  Yes that would be:

a) Our esteemed Congress, a group that makes the Hatields and McCoys look like a model of cooperation. Despite approval ratings somewhere in the low single (negative?) digits, both the Democratic Senate and Republican House were nevertheless returned to power in last week’s election (Way to go America!  Apparently we’re all battered wives now).

And

b) Our newly reelected, newly energized and newly reinvigorated President “Sir Taxalot”.

So to paraphrase Franklin Delano Roosevelt, “we have nothing to fear except some really, really, really scary stuff over which we have absolutely no control and no confidence that the people who are supposed to keep the scary stuff from happening to us will in fact do so.”

I don’t know about you, but I am definitely sleeping in on January 1^st.

In the meantime, “Honey. I’m going to rummage through the basement and see if I can find those old parachutes.  Then I think I’m gonna lay down for a while……”

On the Brighter Side

No seriously.  Let’s see if we can work past a bit of the “gloom and doom” that seems to be hanging around out there.  We will do this in classic “Good News, Bad News and Good News” fashion.

The Good News

As you can see in Figure 1, the stock market has recently fallen into what can be considered “oversold” territory.  Of course, things can always go from oversold to very oversold, so this is not a table-pounding buy signal.  Nevertheless, when you combine this oversold reading with the historical propensity for the stock market to rally around holidays, we should not be surprised to see the stock market bounce sometime in the next week.

Figure 1 – Stock market short-term oversold

The Bad News

The bad news appears in Figure 2.  What we see is that the key broader stock market averages have fallen below their respective 200-day moving average.

Figure 2 – Major stock market averages below their 200-day moving averages

Now I always feel compelled to point out that there is nothing magic about moving averages.  An index can be below a key moving average one day and back above it the next.  So there is no real predictive power.  Still the key point is that you cannot have a major bull market rally while the index is below its 200-day moving average.  Likewise, you cannot have a prolonged major decline while the index is above its 200-day moving average. 

So let me sum this one up as succinctly as possible by invoking:

Jay’s Trading Maxim #176: Price above moving average – good.  Price below moving average – bad.

Which I think sums it up pretty well.

The Good News (Part II)

With the obvious caveat that “each time around is different” and with the other caveat that we have never faced a January 1^st “fiscal cliff” ever before in the history of this country (hmmmm, maybe that Congressional job approval number is still too high), we are entering what is typically a seasonally favorable period for the stock market.

While some measure things in different ways, Figure 3 displays the growth of $1,000 invested in the Dow Jones Industrials Average from the close of trading on November 17^th through the close of trading the following January 7^th (these are actual dates not trading days of the month.  So this year the favorable period starts at the close of trading Friday November 16^th, since the 17^th is a Saturday).

Figure 3- Dow Industrials – Growth of $1,000 November 17^th through January 7^th (1970 to present)

Summary

So should we be worried about the fiscal cliff?  It would sure seem that way to me.  Should we nevertheless give the stock market the benefit of the doubt, given the present oversold level, the seasonally favorable period just around the corner?

It might make sense to keep a few toes in the water.  If the stock market does indeed “climb a wall of worry”, it seems like there’s a heck of a rally out there somewhere waiting to happen.

Jay Kaeppel
Staff Writer and Trading Strategist

Optionetics.com ~ Your Options Education Site