The great market
prognosticators have by now came out with their 2013 predictions about
financial markets. It seems to me to be a fool's game to try to predict what
financial markets are going to do in the future.
I want to be clear in stating
that I do not know what is going to happen in the future. I do not know where
the S&P 500 Index is going to trade tomorrow let alone 6 months from now.
Most market pundits simply will not admit to this fact.
These same market pundits
seemingly are unable to be honest about their own fallibility. In their own
mind they believe it undermines their credibility or will hurt their forward
sales for some book or strategy they are going to unveil. I for one do not
prescribe to that notion, I believe in telling the truth.
The truth is that these
so-called market experts do not know anymore than you or I about price action
in the distant future. However, what I do know is that forward price action
remains a mystery until its unveiled in the present.
Instead of wasting time
discussing potential price action in the future, why not focus on a few
pieces of information that have occurred that are known facts right now. I
think the chart below points out that in the intermediate time frame, equity
indexes are reaching extreme overbought conditions.
As can be seen above, the
number of stocks trading above their 50 period moving averages is reaching
close to the highest levels in the past 5 years. Many times when these price
levels have been reached we witness a correction at the very least and any
short-term gains are usually given back in short order. This is not to say
that prices are going to sell-off tomorrow or in the next few weeks, however
it is a warning that a correction is likely lurking in the not-so-distant
future.
To help confirm this notion, a
quick look at the Volatility Index (VIX) demonstrates just how much complacency
there is in the short-term spot VIX price which is currently trading below 5
year lows. For novice readers when the VIX moves lower the outcome is
typically bullish for the S&P 500 Index and when the VIX moves higher the
reaction is typically bearish in terms of the S&P 500 Index.
As can be seen above, the VIX
is trading near the bottom of its recent range. This helps confirm the
strength we have seen the past few weeks, however a reversal seems likely in
the near future. Should the VIX pick up considerably it would have a negative
impact on the S&P 500 Index. Furthermore, if we go out several months in
time the Volatility Index Term Structure steepens wildly.
What this means is that
traders and money managers have bid up forward VIX contracts in an attempt to
hedge against a variety of perceived risk. I would also point out that at the
moment February monthly options contracts are cheap relative to their
historical volatility levels. However, the VIX could rally violently higher
should the appropriate chain of events take place in the months ahead.
There are several catalysts in
the short-term which will have a major impact on price action for the broader
indexes. This coming week we will have earnings from major companies such as
IBM, AAPL, and GOOG which all have the potential to move the tape
significantly in either direction.
The other more obvious
short-term inflection point is the dreaded U.S. debt ceiling debacle which is
likely to begin permeating the financial media as the deadline for action
draws near. In recent history both houses of Congress and the Executive
Branch have struggled to achieve compromise until the 11th hour. The fiscal
cliff was one issue, but the debt ceiling issue has the potential to have a
major impact on financial markets.
Just to put into context what
happened back in 2011 when Congress could not reach a compromise regarding a
debt ceiling increase, the S&P 500 Index had the following reaction as
shown below.
Obviously there are
significant unknowns regarding how the debt ceiling process will unfold in
2013. However, what is known is that should the politicians wait until the
11th hour equity indexes could force their hands yet again.
Additionally the threat of
credit rating agencies downgrading U.S. government debt is a major concern.
The outcome of this decision alone has the potential to devastate investment
portfolios should the government have a partial shutdown as a result of a
failure to reach an agreement regarding the debt ceiling.
What is important to
understand is that the longer-term price action in the future is impossible
to know at this point. We have major earnings reports which are about to be
released over the next few weeks which presents significant risks to the
broader indexes in both directions. Furthermore we have a major macro event
that is facing us and will have to be addressed in the next 5 - 8 weeks.
The outcome of these events as
this point is entirely unknown. I would also point out that in 2011 prior to
the debt ceiling debacle we saw equity prices rally higher in late June of
2011 while the VIX traded down near recent lows at that time. After a period
of consolidation equity indexes remained patient and gave the politicians
time.
Eventually the price action in
risk assets forced both political parties and the President to come together.
As shown in the chart above, the S&P 500 lost nearly 19% in less than 4
weeks of trading sessions. Even the most skeptical politician was forced into
submission by Wall Street and the financial media.
Will history rhyme with the
recent past? Will we see a compromise in advance of the dreaded shutdown
date? Will the debt ceiling outcome create a major paradigm shift in U.S.
financial markets and U.S. politics?
Unfortunately, there is no one
that can tell us with any certainty what is about to happen in the next 5 - 8
weeks, let alone later this year. After all of the forthcoming analysis and
discussion in the weeks ahead, price action will continue to remain a mystery
until the debt ceiling situation is behind us. Until then, caution is
warranted in both price directions. Trade safe.
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