The lack of a budget deal weighed heavily on
investors’ minds on Friday. There’s a
growing sense that Congress may do the unthinkable and allow the U.S. to careen
over the edge of the fiscal precipice.
If this happens, the initial shock would have a decidedly negative
impact on equity prices, at least in the short term. A defensive posture is important when the
major indices are below the 15-day moving average and internal momentum
readings are mostly negative, which is now the case.
With Monday’s deadline for reaching a fiscal
agreement imminent, Congress convened a late-night session on Friday in the
hope of hammering out a compromise.
Failure to do so would result in automatic tax increases and spending
cuts. I have no inside connections in
Washington, so I can only speculate like everyone else what the outcome will
be. Recently I had the privilege of
interviewing the venerable investment analyst Bert Dohmen, whose work I’ve long
admired. (FYI, you can read the entire
interview by clicking here.)
Mr. Dohmen told me, “Nobody knows if there’s
going to be an agreement among the Democrats and Republicans. The popular view is that there will be a
compromise by year end. But as you know,
the popular view is usually wrong. I can
see a situation where there’s a lot to be gained by Democrats by letting the
country go over the cliff and then blaming the Republicans. ‘The Republicans made us do it’ will be the
excuse.”
We can only hope that Dohmen’s fearful
scenario doesn’t happen. Regardless of
the outcome, the immediate-term trend for equities is bearish based on a
reading of the indicators. We’ll review
some of these indications in tonight’s report….
[Next few sections deleted in fairness to
subscribers]
Now let’s turn our attention to market
volatility. Last week I cautioned that
we’d need to be on our toes from here on out in anticipation of increased
volatility. Along those lines is the
disturbing pattern visible in the daily chart of the CBOE Volatility Index
(VIX), shown below.
VIX has since spiked to its highest level of
the last six months, which shows us just how worried investors have become in
the face of the forthcoming Congressional deadline for averting the fiscal
precipice. A conspicuous rally in the
VIX typically means the immediate-term market trend is in its final critical
stages and often precedes a short-term market bottom. But as of Friday, Dec. 28, there’s no indication
that a bottom has been made. Therefore
we should be prepared for more potential downside next week.
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