The Day Ahead: Break Out the Whooping Stick

Over the election, I've been pushing the envelope to the point of an exhaustion-fueled hospital trip, all in the name of not getting throttled by an unrelenting market -- so I felt it highly necessary to tune out for a bit. I slapped a "do not enter" sticker on every social-media entrance sign and wanted to completely detach from humanity. However, the momentary respite did not last long, as I was sucked into reading 10 macroeconomic strategist assessments, two earnings calls and 51 articles -- inside of two afternoon hours.

What did I learn? Not a darn thing -- the storylines were eerily similar throughout this clubby street named Wall. The only competitive advantage in the various notes went to those who conjured up cool factoids gleaned from 13-stage multifactor models tweaked before the election. The investment themes were the same.

I reckon that we need to break out the whooping stick. In wielding this -- oh, let's just say it's an axe -- one could chop through the sea of copycat themes and decipher what is really happening, and the possibilities in upcoming sessions. Here are the fruits of my laborious exercise.

Fiscal Cliff

In the aftermath of the election, what we were forced to witness in the markets was not the full pricing in of the fiscal cliff. That process, as I indicated in October, began following the September Fed meet-and-greet. So, assuming that Fed meeting was the starting line for when the market slammed down the valuation-reset button, what is left to be priced into stocks that could prevent a "buy-on-the-dip" approach?

  1. One factor may be worse fourth-quarter earnings growth vs. last year, as compared with that of the third quarter -- and results that are below shaved estimates. A whole bunch of low-quality quarters are forthcoming.
  2. Also probable are intra-quarter earnings warnings. This should occur as companies realize third-quarter stabilization in certain hard-hit European end markets was a head-fake, as suggested by Polo Ralph Lauren (RL). The U.S. fiscal cliff should only throws gas on the embers -- companies are likely to protect cash piles, order inventory cautiously and to refrain from chasing budding opportunities in Europe. All this perpetuates the economic stagnation.
  3. If left to fester, the fiscal cliff should render the third quarter a disappointing cycle peak. The fourth quarter rate, then, should emerge as chopped down to size -- growth of 1% to 1.5%. In the first quarter of 2013, growth should go negative.
  4. The holiday season should upend the optimistic projections of retailers. That, in turn, stands to impact first-half 2013 inventory planning and longer-term investments. The economic ramifications here are obvious.

Federal Reserve

Go buy a cow brander, stuff it in some coals and place this on your forearm: Dec. 12. That is the Fed's final meeting for 2012, and at the moment it's littered with many branches of risk that mix well with the market's fiscal-cliff pricing adjustments.

First, Operation Twist is scheduled to end. If the November employment report surprises in a similar manner to that of October, and if we also score some upward revisions, the Fed may not be as aggressive as the market demands -- and has priced into stock valuations. (Trust me, the Fed effect is still there.) That would leave the fiscal cliff frighteningly front and center, with some open-ended monthly bond buys that are not kick-starting growth. Interest rates would tighten, I think, and dent sectors that have worked decently, such as housing.

Second, all eyes are on the 2013 estimates to the Fed's economic projections. On the release of the last set of targets, the Fed slightly raised its gross domestic product forecast for 2013, but left the core personal consumption expenditures index unchanged. Mr. Market says this could be reiterated Thursday. #NoGood

Of course, if the market continues to cede ground into the December Fed extravaganza, an investor will have to be prepared to act opportunistically. Amid more attractive valuations, and as the market forces the Fed's hand, Stocks could enjoy a typical pop from odd easing efforts. (Fed chief Ben Bernanke loves the market). For the time being, though, stay overweighted on cash -- meaning, in my realm of no jargon, have a higher amount of cash on hand as opposed to risk on the table.

Reassessment Checklist

First: We'll see the Russell 2000 reach 796 and change (the Aug. 14 close)

Why: The index should hold convincingly as the possible signal fiscal cliff is minimized -- and, with it, the domestic economy will averts the worst-case scenario.

Second: We'll see 1365 on the S&P 500 (Aug. 2 close)

Why: It holds convincingly; stocks will have survived the resurfacing of Europe headline risk and first round of fiscal cliff shock.
At the time of publication, Sozzi had no positions in the stocks mentioned, although positions may change at any time.

Brian Sozzi is Chief Equities Analyst for NBG Productions. In this capacity, he is responsible for developing independent financial content and actionable stock recommendations (including ratings and price targets) for an institutional and retail investor base. In addition, Sozzi is the Editor in Chief of the "Decoding Wall St." investor education online platform.