Fiscal Cliff Plan C?
Last evening House Speaker John Boehner cancelled a vote for his “Plan B,” which would have allowed for an extension of the Bush era tax cuts for all those making $1,000,000 or less. Keep in mind, “Plan B” had no chance of becoming law as President Obama would have vetoed the measure. The immediate reaction from the media has been to focus on the Speaker’s inability to pull together his caucus. For the capital markets, that should not be the focus.
In the wake of the announcement I was asked to phone into the Larry Kudlow show on CNBC. As I picked up the phone, my attention quickly turned toward my trading screens as the futures for the S&P went into free fall. Take a look at the chart below (Figure 1.1), and you will find the futures at 8:15 p.m. trading down -12.25 handles at 1428.25. Within two minutes, the election of stop loss orders sent the futures to a low print of 1391.25 down -49.25 handles. The Dow futures (Figure 1.2) declined also to a low of -304. However, by 8:20 p.m., the futures market stabilized as the Dow futures were only down -195 and the S&P futures traded back to 1419.50 down -21 handles.
Investors should look at the knee jerk reaction in the futures market as an indication that most institutional market participants have closed the books on 2012. The type of price action represented in those five minutes should be characterized as “holiday trading.” In addition, today is equity options expiration, which again may place the SPX in the uncomfortable hands of short-term beta chasers. That is not a favorable environment for investment decisions.
As I shared with Larry last evening, I do not view the cancellation of a vote on Plan B as confirmation that fiscal cliff negotiations are over. If I am wrong and, in fact, we are about to go over the cliff, investors can expect a fiscal drag of at least $550 billion for 2013. However, I still expect a compromise can be agreed upon. At the very least, the Bush era tax cuts could be extended for those earnings $250,000 or less, which could shave the 2013 fiscal drag in half.
I expect the best posture for investors to take is that of spectator. As the calendar flips into 2013, the environment and institutional fund flows will provide a better road map for investment decisions. Within the next few weeks, the capital markets will telegraph for how much longer “It Remains a Bond Friendly World.”
Figure 1.1 S&P Futures for December 21 Trading
Figure 1.2 Dow Futures for December 21 Trading