The Day Ahead: Living in the Nightmare

It feels as if investors are being forced to live a nightmare. With pros now musing that a fiscal base jump deal is near, and stocks chilling at key moving averages, the game of projecting the next direction of the market has become infinitely more difficult. Everybody wants to be a bottom-picking hero, snagging their moment in the sun by playing a contrarian card while the masses use solid principles of investing and dump -- as opposed to utilizing god only knows what kind of analysis.

The reality is that there is nothing new to dissect. We are in a holding pattern where investors are forced to avoid most of the riskier pockets of the market and hit the "source of funds" button on dividend payers due to the threat of being blasted by the tax man. All I am able to offer is the truth, which is situated in obsessive market watching and spying clues not necessarily on the fiscal cliff, but rather on the state of the union for companies at the beginning of the fourth quarter.

What the Market Is Saying

Any signs of fourth-quarter business improvement, especially in globally connected industrials, have gone unnoticed. The global macro scene is so precarious that any sequential turn in pricing, volume, or profit margins after a weak third quarter is unsustainable. A great example of this is W.W. Grainger ( GWW), a company that told us its November sales were better than the October rate. However, the market pulled the pants off the company's month, rendering that core demand (volume -1%) failed to achieve any real acceleration, the headline optimism by management was a function of a Sandy related sales jolt. In fact, I would go so far as to note Grainger's month had broader negative implications on the economy.

Pricing was higher by 4% in the month compared to the aforementioned 1% volume decline. Not only were Sandy expenses unplanned, but a public company was advantageous on its pricing to its impacted consumer base. So, and I reiterate this, as we get these types of Sandy-laden reports it will embolden the bears who suggest fourth quarter GDP is set to print well below consensus forecasts. Normally in such a case this would create selling pressure in higher beta areas of the market and buying interest in perceived "safe havens." The problem is that "safe havens" are the dividend payers that may get slammed by Uncle Sam. Where do investors hide out? Probably in cash or the 10-year note and hence, the market trades sideways with a downward bias.

This is the fiscal base jump in play: It infects sentiment (good news is ignored/bad news is really bad = stocks are ejected from the portfolio regardless) as it casts a thick, black smog over future earnings streams of companies. I don't mean to be the bad guy in pointing these things out -- wait, actually I do. If you have not woken up yet in the real world it's time to do so.

But either way, humor me a bit. For each company you own, find its 2013 earnings estimate and present P/E multiple (note: the S&P 500 is around 12.8x) off that forecast. Select at least five companies you are considering to buy, as well. Shave $0.10 to $0.15 from those 2013 earnings estimates and mark the projected P/E multiple down by 10%. I characterize this as the "worst case scenario." Compute to get a hypothetical stock price, compare to the latest quote. I would bet that the outcome of this exercise yields a majority of the stocks still trading nowhere near a worst-case scenario for the U.S. economy and subsequently, how that impacts overseas markets. Now, do I expect the end of the world due to temporary government inaction and then, domestic style austerity? No, the point here is that stocks have room to go in pricing in an even less dire fiscal cliff scenario. You dig? I remain bearish.

P.S. Williams-Sonoma ( WSM) boasts positive pricing action relative to its specialty retail group pre-earnings (and broader retail, which has been beaten into the ground since September). Ethan Allen ( ETH) had a strong quarter, and Williams-Sonoma caters to a similar customer.
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.