Delayed T-Report: 12 Hours Does Not a Year Make

Posted by on Jan 3, 2013 in The T-Report | No Comments

12 Hours Does Not Make a Year

So here we are with S&P futures up 60 points since Monday morning. Clearly the Fiscal Cliff deal must be a good deal?

I just can’t get there.

I don’t think going over the cliff was priced in, and certainly not at 1,430, so the strength is a bit surprising, and I have to respect that and see where I’m wrong, why 1,450 is cheap, when I thought 1,430 was rich.

I hear a lot of talk about investors needing to get long. That too many were hedged. That too many people didn’t put a lot of money to work. While that may have occurred in the last couple of days of the year, it’s not how the markets seemed most of December. Most of December struck me as people getting positioned for a cliff resolution AND for QE. I find it hard to believe that on low volume days like last Friday that degree of bullish positioning changed.

In fact, right now, my sense is there are a lot of people sitting very long risk assets and beginning to wonder when the short coverers and performance chasers will step up and take them out of their positions. I believe that the number of people looking to add risk has been greatly overstated by those already “sneakily” long risk waiting for others to step in.

And it isn’t as though this market has been great at digesting news quickly. The most recent example was the election. Futures were up until some time in the morning when the markets decided an Obama victory was both a surprise and bad and we started a pretty relentless sell-off, in spite of initial “all clear” signals.

What Does Not Going Over the Cliff Mean?

I have definitely been guilty of this myself, but it seems that a lot of time was spent on going over the cliff versus not going over the cliff and relatively little time spent on analyzing the various possibilities in between.

I am kicking myself for not spending more time on this in advance. Was the payroll tax holiday an obvious inclusion? I guess so, yet, didn’t see it mentioned that often, and of all the things the Democrats fought for, it seems a bit surprising this one was so quick to expire.

The 20% capital gains and dividend tax rate. To me, this seems better than many expected, or feared, but again, hard to tell.

Then there is the lack of spending cuts. Good in that it avoids “austerity” in the near term, but bad in that it makes the already debt ceiling negotiations even more contentious and fraught with political grandstanding.

So we have a “resolution” and avoided the “fiscal cliff” but I think people are just starting to figure out whether we avoided it in a way that is positive for the economy and markets or not. This really wasn’t a binary decision. Whatever solution occurred, would have a high degree of complexity and figuring out what the components add up to and mean is key.

I keep coming back to the fact that this deal is bad because:

  • Debt Ceiling and Spending Cuts left for next group to fight over, and the mood in Washington is more contentious than ever and the Republican party in particular seems like they’ve been played like a fiddle, and are likely to fight back
  • People’s paychecks will be smaller, largely as a result of the payroll tax holiday. I don’t know what percentage of Americans really paid attention to the Fiscal Cliff, but I bet it isn’t as high as we would like to think, and that far more people will be surprised by a smaller paycheck than we realize. That is bad for spending, and if my family is at all representative of the country, they spent far more time watching some Dancing Mom show, and this Turtle hillbilly, than being tuned into news yesterday.
  • People have been positioned long and were expecting the fiscal cliff to be avoided and for QE to kick in. A couple of low volume fear days at the end of the year did not change that.

Seasonality is generally strong the first day of the year (or at least it has been the past 4 years) making any analysis of today’s price action even harder to guage, but I remain small short which I recommended this morning. Longs I think are still better placed in Spain, Italy, China, European banks, and other beaten down sectors, but profit taking here is fine and even getting flat in case I’m right about longer term reaction to the cliff deal and we see weakness.

In fixed income, I would be selling bonds, and would NOT be short via CDS. The CDS market may move wider first and there might be a comfort with holding much beloved bonds, while shorting CDS, but the reality is, CDS has far more potential to tighten here than bonds, particularly in the high yield space where convexity is a real problem for the third of the universe that is trading yield to call.

Non Farm Payroll could be interesting. Last year we saw some great numbers in the winter. It will be hard to compete with this year since the weather hasn’t been as cooperative and I can’t help but think that the seasonal adjustments will be less extreme as 2008 and 2009 recede in time.


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