"Noise proves nothing. Often a hen who has merely laid an egg cackles as if she laid an asteroid." - Mark Twain
Markets "tumbled" 2% last week as "panic" set in over the Fiscal Cliff debacle, or at least that's what the headlines say. Negative sentiment has swelled as a result of the incompetence of Washington, with many crying fire and calling for an imminent collapse in markets. Someone forgot to mention to these people that 1) the S&P 500 (NYSEARCA:SPY) routinely goes down 2% looking at stock history, 2) small-cap and emerging market (NYSEARCA:GMM) stocks which are cyclical in nature continue to outperform strongly, and 3) the VIX (NYSEARCA:VXX) is at the highest level since June when the melt-up in equities began and as the "end of the world" negative narrative rhetoric was at its peak.
I see commentators argue that another collapse in equities is likely, similar to the Summer Crash of 2011 which we are known for having called last year. None of these commentators called that specific decline, and intermarket trends show absolutely zero similarity to the distortion that caused the 2011 breakdown in risk assets. It is striking to me how convinced people are over the idea of another end of the world scenario, ignoring the fact that as of this writing, the S&P 500 is down a little under 1% for the month. Emerging markets are UP over 4%. The claim that higher taxes and austerity in the U.S. would cause a collapsing equity market seems to completely ignore Europe and its markets in 2012 under the same, if not worse, conditions.
But what about the Fiscal Cliff? As I said on CNBC Thursday, the end result of what's happening is not risk-off. Rather, the end result is risk rotation into emerging markets. The rhetoric is not being backed up by intermarket trends and price behavior. This is not a matter of being stubborn about the "risks" but rather about the consistency of our process and listening to price, which remains bullish. The broad market averages are masking underlying strength. Evidence of this can be seen in our ATAC models used for managing our mutual fund and separate accounts, which continue to perform well by staying in equities which are leading large-cap averages.
As to whether the Cliff happens or not, I am more intrigued not by politicians' words, but by incentive. The very wealthy would take a bigger hit from a collapsing stock market than by an income tax increase. Think this idea through. The rich are not rich because of income, but because of assets. Public markets are often the benchmark for valuation in private deals. A collapse in public markets would disproportionately hurt the holders of assets (the very rich) more than the holders of income (everyone else). So what is the incentive then for the Republicans to not negotiate on behalf of their constituency when making a deal might actually be the lesser of two evils?
Never mind the fact that the Fiscal Cliff is not actually a Cliff but rather a process. Never mind the fact that tax increases even if the Fiscal Cliff happened might be offset by lower gas prices due to fracking and the consumer saving money on energy costs. Never mind the fact that the Fiscal Cliff has now become a household term with countdown clocks everywhere. Never mind the fact that pessimism and negativity are not strategies when it comes to markets which have had a stellar year in 2012. We choose to respect price and market history. Right now, the risk is not a collapse, but a surprise spike. Unless a dramatic change in internal market behavior takes place, we remain positive in the near-term, continuously working to take advantage of inflation and deflation pulses through our ATAC models.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.