Did They Forget To Ring the Bell? Holding Pattern Ahead Of Fiscal Cliff. Mini-Deal Likely.

December 7, 2012
Author: Peter Stolcers, Founder of OneOption
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Pete

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This has been one of the tightest trading ranges I can remember this year. Since Thanksgiving, SPY has closed within $.50 of $141. The range during that time has been $1.50 in either direction. Major economic releases did not move the needle this week. All eyes are peeled on Washington DC.

Politicians hold the cards and from my perspective the tone is souring. If Republicans don’t cave in on tax hikes for people earning more than $250,000, President Obama will take us over the cliff and he will make it look like their fault. Then he will propose to lower taxes for anyone making less than $250,000. He will look like a hero and there is no way that Republicans would fight this.

The GOP does not have the upper hand. They need to concede and they can sweeten the pot by removing some tax loopholes for upper income Americans. Once the kitchen sink has been served up on a silver platter, the ball will fall squarely in the Democrats court. Republicans would have a bargaining chip if they did this. It would show good faith on their end and they could wait for Democrats to respond.

If substantial spending cuts and entitlement reform are not part of the Democrats counter-offer, the Republicans should not raise the debt ceiling (that is a bargaining chip if they follow this course).

All of the tax increases in the world won’t solve the problem. Even these tax hikes will only fund the government for 8 days. This is a spending problem, not a revenue problem and Republicans need to get that message out. All we hear now is that Republicans support tax breaks for the rich.

Democrats are only offering cost savings to Medicare ($300 billion from who knows where) and they want a $50 billion stimulus package. Entitlement reform has barely been mentioned. There is some talk that the eligibility age will be raised to 67 and that means testing will limit benefits to the rich. This is a long way off from any meaningful solution.

Both parties are miles apart and the clock is ticking. I don’t believe a deal will be reached before the end of the year. Republicans and Democrats will agree to extend Bush tax credits for people making less than $250,000 per year and we will go over the cliff. Democrats will postpone spending cuts and the “Battle Royale” will start in January when we bump up against the fiscal cliff.

Rumor has it that President Obama has researched the 14th amendment. His team does not believe that he has the power to raise the debt ceiling and he is not likely to pursue this course of action. That means he has to negotiate.

I am trying not to get political in my market commentary. As a trader I need to evaluate both sides and I need to look for points of strength so that I can evaluate possible outcomes and forecast their impact on the market. When it comes right down to it, all politicians in the last 40 years have let us down this path. Entitlement needed to be reformed decades ago but no one dared to touch the “third rail”.

If a “mini-deal” is reached, the market could stage a rally into year-end. The move higher will be very contained and many investors will sell into strength. Uncertainty lies ahead and this economic cycle will finally have to take its natural course.

Central banks are out of bullets and quantitative easing has not stimulated economic activity. Interest rates are already at zero (US, Europe and Japan). Deficits are ballooning and prior stimulus programs have not worked.

Global economic conditions are stable. Germany’s central bank said that they are likely to head into a recession. Weakness in Europe is offset by marginal growth in China. The US is flat lining.

China will release major economic data over the weekend, but decent results won’t matter. All eyes are on the fiscal cliff.

The closer we get to Christmas without a deal, the greater the likelihood of a swift decline.
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