Daily State Of The Markets: Noodling On 'The Solution'

by: David Moenning

Stocks blasted higher on Monday as the indices enjoyed their best day in more than two months. The reason for the joyride to the upside was pretty straightforward as all sides of the fiscal cliff debate decided to talk nice over the weekend. As such, those betting that the U.S. would plunge into recession come January 1 did some rethinking and those who had pressed their bets to the short side scurried for cover.

Sure, there were other issues at work yesterday including a big day in Japan on the hopes that a new election might bring more stimulative measures and word that the latest decision on Greece could come sooner rather than later. But the bottom line is this is the way the market works these days. Stocks correct on fear over this or that and then come roaring back when something occurs to cause the fears to diminish.

Although I've heard many analysts espouse that a resolution to the cliff negotiations will be good for a quick pop of 5% - 10% on the S&P 500, I'm not so sure the issues at hand are as simple as some are making them out to be. You see, the "solution" to the cliff may take many forms. And despite the public pledges by both sides to play nice with each other this time around, the cliff remains a political issue and last I checked, neither team thinks they really need to back down.

So, the first thing to recognize on what may be the last real trading day of this holiday-shortened week, is that "the solution" to the cliff issue(s) isn't likely to be quick or easy. And the second thing we need to noodle on a bit is what that solution is going to look like.

For me anyway, the key question is if the solution will actually be a solution or something more along the lines of an agreement to talk about a solution at some point in the future (aka the "kick the can down the road" solution). Think about it; should we really expect any meaningful agreement to get passed on the issues of taxes, the budget, and the debt during a lame duck session of Congress? And since there is no real hard and fast deadline on the issues at hand, I am having trouble jumping on the "it will be signed, sealed and delivered by Christmas" band wagon.

The next thing that keeps rambling around in my brain is the question of which comes first; the chicken or the egg. In this case, I'm talking about the issues of economic growth and earnings. In case the recent 7.7% correction in stock prices didn't make it perfectly clear, the most recent earnings season was a bit of a disappointment. As we've reported before, while 70% of the companies did find a way to "beat" their earnings per share estimates via reverse financial engineering, the real key to the earnings season was the fact that only 40% of the companies in the S&P 500 beat revenue estimates.

Cutting to the chase, this means companies didn't make as much money as they and the analysts had expected (remember, if a company knows that their earnings are going to be punk, they have a responsibility to "guide" lower prior to the quarterly report). And generally speaking, this occurred because the growth rate of the economy has been slowing in 2012. So, unless the pace of economic activity doesn't perk up - and right quick - then we can probably expect more of the same from the Q4 reporting season.

However, there are those who argue that "the solution" to the cliff issue will cause confidence to return and the economy will turn on a dime. Some have even argued that we're already seeing the downside to the cliff right now. For example, in a front-page story, the WSJ reported Monday that the paper's review of filings and conference calls indicated that half of the U.S.' largest companies have said they will cut capex (capital expenditures - i.e. business investment) this year or next. The article surmises that uncertainty about both the just-concluded elections and the pending fiscal cliff are making companies think cutbacks are warranted. Therefore, the bears argue that the downside to the cliff is already happening.

So ... IF our elected officials can find a way to come to a "grand bargain" - and soon - then I will opine that there is a chance that sentiment could do a U-turn and the negatives of the cliff will stop on a dime. But if not, then I'm guessing that the economy will continue to muddle along at best and corporate America will continue to see declining revenue growth. And unless I'm wrong, neither would be terribly positive for stock prices. But, rest assured that I will continue to noodle on this - because I definitely have been wrong before.

Turning to this morning ... The Moody's downgrade of France's bond rating announced after the close yesterday put a damper on the sentiment in the global markets overnight. Stocks in Asia failed to follow Wall Street's lead and actually fell across the board while European bourses are also seeing modest declines in the early going. Here at home, Dow futures are pointing to pullback of about 40 points at the present time.

On the Economic front ... We will get reports on Building Permits and Housing Starts this morning.
Thought for the day ... When you get to the end of your rope, tie a knot & hang on. -Franklin D. Roosevelt
Pre-Game Indicators
Here are the Pre-Market indicators we review each morning before the opening bell ...
  • Major Foreign Markets:
    • Shanghai: -0.40%
    • Hong Kong: -0.16%
    • Japan: -0.11%
    • France: -0.37%
    • Germany: -0.01%
    • Italy: -0.59%
    • Spain: -0.47%
    • London: -0.08%
  • Crude Oil Futures: -$0.46 to $88.82
  • Gold: -$2.70 to $1731.70
  • Dollar: higher against the yen, lower vs. euro and pound
  • 10-Year Bond Yield: Currently trading at 1.624%
  • Stock Futures Ahead of Open in U.S. (relative to fair value):
    • S&P 500: -4.59
    • Dow Jones Industrial Average: -42
    • NASDAQ Composite: -9.63
Positions in stocks mentioned: none