Has the stock market already had its rally to celebrate a fiscal bargain – before any such deal is final?
It’s possible this is the case – and quite probable the past month’s market gains have left the major indexes less able to shrug off any possible false starts, delays or threats of “no deal” in the ongoing talks to bridge the divide on taxes and spending separating President Obama and House Republicans.
The market never waits patiently for the all-clear signal of a definitive headline before trying to price in expected news.
This helps explain why the Standard & Poor’s 500 index has gained nearly 7% in the past month, to rise above 1,440, as the biggest economic story has been the impending “fiscal cliff” – and the main plotline in this story was the lack of progress in negotiations.
The Prevailing View
Since around Election Day, the prevailing view of market handicappers has been that the uncertainty of the fiscal future was restraining the market, but that, once clarity was achieved, stocks would bound higher.
This was never likely to be the enduring driver of market fortunes, yet the market has apparently gone ahead and taken at least a “down payment” on the anticipated fiscal-pact rally upfront, in its habitual refusal to let noncommittal investors in when it’s most comfortable.
The immediate risk facing investors who have stayed on the shoulder as stocks have gone speeding past is that, at least in the short term, a final agreement on tax-and-spending details will present a tidy “sell-on-the-news” opportunity.
The monthly Bank of America Merrill Lynch global fund manager survey found that the percentage of respondents naming the "fiscal cliff" as the top major risk to the market and economy fell from 55% to 47% while they raised their growth expectations sharply. This supports the idea that the peak in market fear of policy risks has past, which in turn suggests that the market’s likelihood of being pleasantly surprised by a deal has diminished.
Holding Exposure Steady
At the same time, institutional investors held their exposure to stocks steady from November to December, so while claiming more confidence, there still appeared to be room for under-invested players to chase the market higher.
Surveys of investor optimism have shown some cheer spreading. The latest weekly Investors Intelligence poll of financial advisors shows 46% bullish on stocks versus 24% downbeat. That’s edging toward the kind of lopsided happy consensus that serves as a contrary warning sign, but is not quite as extreme as the levels that preceded severe market skids at other times this year. A selloff in gold and Treasury bonds is likewise indicating a revival of risk appetites, which certainly has room to build more momentum before fading.
Plenty of technical analysts, who use charts and index levels as investment-timing cues, were preaching caution with the S&P 500 trading below 1,420, but now are suggesting it’s safe to buy in for a run above 1,500. The upward sprint since the recent Nov. 15 low is now approaching 25 trading days, often when a rally stalls or recedes.
The market’s move to price in a deal that gets us past the "cliff" is, of course, mixed in unknowable proportions with firmer economic news, hints of a long-awaited revival of Chinese growth, traditional late-December seasonal strength and the burning off of a stubborn fog of investor skepticism that has kept many defensively positioned, despite the S&P 500’s tidy 15% gain this year.
In truth, most of what’s powering this upturn in stocks is the unwinding of excessively clenched-up pessimism that took hold in the post-election sell-off. Once that relaxation trade plays out, the question will become how investors synthesize the details of any fiscal plan along with the economic signals for 2013. The domestic economy has picked up a bit, and the market has conveniently managed to stay aloft while analyst forecasts for the fourth quarter have been reset down from a consensus of 10% growth to 4%. This is a more reasonable level that raises the chances for companies to begin hurdling estimates.
Before then, though, this slightly overextended tape will likely be susceptible to some passing excuse – or good reason – to pull back to a degree that late-coming bulls will feel it. If this doesn’t follow the debt-ceiling-drama script of 2011 – when a similar rally fell apart as Congress played a game of chicken that both sides lost – then the elements of a “small bargain” in Washington could give investors pause.
Barry Knapp, strategist at Barclays, has been making the case that even a deal that averts the automatic "fiscal cliff" government retrenchment will involve a noticeable drag on economic performance, such as the reversal of payroll-tax waivers that have bolstered spending capacity of all employed Americans. His call is that this could mean the first sizable market move in 2013 will likely be lower as some of the constraints on growth come into focus.
This wouldn’t necessarily dictate the prospects for all of 2013. But such a correction would certainly dispel the popular idea that, if only the adversaries in Washington can come to a handshake deal, they will win an immediate and sustained ovation from the market.