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The Election Correction

10/24/2012

Last Friday, I posted a blog highlighting my concern over the lousy earnings reported so far this season, in particular for technology. Tech heavyweight Apple (AAPL) reports on Thursday, October 25, after the close. It will take quite a robust earnings report and strong guidance to reverse the negative momentum established so far from tech companies. In fact, AAPL closed Tuesday at $613.36, below both its 50- and 100-day moving averages, despite its afternoon release of a new product, the Mini iPad, and a refresh for the MacBook Pro. AAPL (Figure 1.1) is now uncomfortably close to its 200-day moving average at $585.04. It has not been so close since late 2011. 
 
AAPL Earnings Estimates:
•  EPS $8.83 and Revenue $36.2 billion
•  Guidance for next quarter –  EPS $15.50 and Revenue $54.9 billion
•  Current quarter IPhone sales 25 million; next quarter 45 million
 
The S&P 500 Index (SPX) (Figure 1.2) has now closed below my 1422.38 technical reference point. The overweight risk assets trade from early June should be neutralized. Investor allocations should be reduced back to market weight. In the case of 2012 underperforming assets, I would suggest reducing further to underweight. We are now in the midst of a modest election correction.
 
The SPX tonight sits at 1413.11. I suspect that closing price is not based solely on disappointing earnings. Rather, with the U.S. presidential election just 13 days away, the outcome is as uncertain as any time since the campaigns began. Keep in mind, when I state “the outcome” my focus is always on the Electoral College. The outcome in the Electoral College is statistically very close.  
 
Additionally, I am concerned there is the potential for a November 7 scenario in which the winner is still unknown, or where one candidate has captured the Electoral College and the other the popular vote. I expect the motivation for those currently shedding risk to reassume risk in the 13 days ahead of November 6 will be rather limited. Maybe AAPL saves the day with stellar earnings and guidance, but that scenario has long odds.
 
Most likely heading into the election, the SPX trades sideways to lower with the all-important 200-day moving average at 1375.34 providing structural support. Markets despise uncertainty. The outcome of the election and a potential fiscal cliff compromise are very uncertain and therefore the expectations for a resumption of 2012’s prevailing bull trend should be tempered until we know the November 6th result.
 
Lastly, two inside baseball observations:
1.  I am still watching very closely the price action of the 10-year U.S Treasury. In fact I viewed Tuesday’s price action, a closing yield of 1.76%, as rather interesting. On a -243 point Dow Industrials drop, Treasury prices should have rallied more than a 5.6 basis point move lower for the yield. In contrast with prior SPX corrections since 2009, I don’t expect Treasuries to provide a port of safety for this correction.
 
2.  I am also keeping an eye on the “confused” currency market. Favorable risk asset markets generally require an obvious carry trade. I posture what is the funding currency for that trade? Currently, there is no funding currency nor an obvious carry trade – not a favorable condition for further SPX appreciation.
 
So, enjoy the World Series and Halloween. The market is taking a pause.  The collective evidence still suggests it will refresh. The overweight trade from early June was excellent for investors; for now a modest correction isn’t so bad either – it is actually healthy.  
 
Figure 1.1 Apple (AAPL) prior year with 200-day moving average annotated

Source: Bloomberg
 
Figure 1.2 S&P 500 Index (SPX) 

Source: Bloomberg

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