The Fiscal Cliff

Apparently, Congress has secretly agreed on one key measure.  As their Motto of the Month, they adopted writer Douglas Adams’ pithy line:

“I love deadlines. I love the whooshing noise they make as they go by.“

I don’t have a clue how the fiscal cliff measure will be resolved.  It’s not looking good, but most insiders and professional prognosticators say the pols will pull something out of their collective arses in time to avert a disaster.

Our forecast argues otherwise, but every analog breaks eventually.  And, presumably a deal would be bullish — goosing the markets by who knows how much.  For those who, like me, are short — it’s always smart to use stops.

If SPX exceeds 1448, Tuesday’s reversal at the Fib .786 of the 1474-1343 decline, then the .886 at 1459.56 is the next target.  If that’s taken out, the next upside would be the 1474 top itself.  If that’s taken out, there are a number of higher Fib targets over 1500.

Stops should be set according to your risk tolerance, your current position, and the type of trading you do (swing, day, long-term, etc.)   In my swing trading, I tend to choose stops that are just beyond the last Fib level that completed the primary pattern that’s currently directing prices.  So, a stop around 1450 would apply to a push through the 1448 level on the way to the .886 at 1459+.

I’ve written too much already on the FC, but it’s obvious that any agreement, regardless of when it comes, will involve some combination of lower government spending and higher taxes.  There can be no immediate economic upside in such an eventuality, though theoretically it could chip away at our longer-term problems — which in my estimation are virtually insurmountable.

In the Great Depression, prices across the board and around the world were generally allowed to reset.  Debt was written off, and those who survived picked up the pieces and started over. Bernanke, who fancies himself an expert on all things depressing, is running a grand experiment to see if propping up prices — particularly of financial assets — can avert a replay of the 30’s.

I suspect not; but, the truth is no one really knows.  Twenty years from now, it’ll be obvious (assuming the world doesn’t end tomorrow.)  But, for now, it’s a high-stakes crap shoot — a desperate measure in response to desperate times.

In the meantime, the market will react one way or the other — which might or might not be in concert with the perception of any deal.  Remember QE3, which was good for a whopping 40 points on SPX?  We have a (so far) very successful analog in place that’s racked up gains of about 40% in just the major moves it’s called since April.  I’ll stay with it until the market — not the talking heads — signals otherwise.

*  *  *  *  *  *  *  *  *

ORIGINAL POST:  9:25 AM EST

Looks like a mixed opening.  The dollar and EURUSD have each retraced a Fib .886 of yesterday’s reversal candles.  Bat Patterns completed, they appear poised to pick up where they left off.

Focus should be on the fiscal cliff and Boehner’s terse announcement yesterday of the House’s plan to pass the so-called Plan B.  It will be rejected by the Senate and White House, of course, meaning it is a purely symbolic effort that won’t do much to ease fears that there will be no compromise.

UPDATE:  11:45 AM

The Philly Fed Business Outlook Survey is out, and shows decent improvement at the margins in both current conditions and optimism.  But, don’t read too much into the monthly figures with a diffusion index such as this.

Diffusion indices represent the percentage of respondents indicating an increase minus those indicating a decrease, so it largely ignores those reporting/expecting no change — which actually increased from last month’s negative report.

In November, the 53% who thought there was a change saw things swinging negative by a 3/2 margin.  This month a lesser amount (47% versus 53%)  see things swinging positive by the same 3/2 margin.

In October, it was 5:4 positive for the 53% who noticed a change — the first positive month in many.  The chart shows the general trend is a series of higher lows and lower highs — a triangle.  As we all know, these can break either way.

An interesting weekend project would be to download the data and look for harmonic patterns.

I’ll post something on the housing numbers later today if the markets remain quiet.  Bottom line, it’s another indicator of optimism.  The builders and buyers might be right, or they might be wrong.  Refer to yesterday’s post and the interview with Robert Shiller for a more meaningful take.

continued for members…

UPDATE:  2:20 PM

I’ve been taking a hard look at financials the past several days.  They have reportedly broken out, which has attracted a lot of attention.  But, I believe we’re looking at a temporary throwover rather than a true breakout.

First, a general overview of the harmonic picture for the market is in order.  As I mentioned at the top of this post, much of the short-term will likely hinge on the outcome of the fiscal cliff arm-wrestling.

But, I’m operating under the assumption, based on our analog, that 1448 was the interim top and that the general direction will be down from here. The operative harmonic grid, in that case, is the purple one.  If the market continues to fall, I will update and augment the downside targets.

SPX led off with roughly 16 pts from the top, reaching 1432.82 this morning.  This was the .146 of the 1343 to 1448 rally (purple) and the .786 of the 1438-1411 decline (small red grid.)  If we treat 1448 as the interim top, the next significant target would likely be the .382, .500 or .618 of the purple pattern (@ 1408, 1395 and 1383 respectively.)  Again, my primary forecast calls for such a move.

But, as with any Wave 1 down — and, setting aside the effects of any influential channels, etc. — we would normally expect a Wave 2 retracement of anywhere from .618 – .886 (1442.2 – 1446.27.)  SPX hit 1442.31 just a bit ago; so any further upside would likely target the .786 at 1444.75 or the .886 at 1446.27.

We’ve seen plenty of deep retracements lately, so don’t be surprised if we get one this time.  The key will be a strong push up through the .618 at 1442.20.  As discussed above, a move above 1448 opens up 1459+; while a push below 1432 opens up 1408 and lower.

Turning to XLF, it’s in roughly the same position. First, the big picture for orientation purposes:

The yellow channel on the weekly chart above is the key to this discussion.  It’s exact location is less important than its slope.  It should be apparent that the slope is pretty accurate as drawn, given the way it provided for breaks between rallies and slumps.

Whenever dealing with a large channel that covers this much real estate, I insert a smaller channel that parallels its big brother.  This smaller channel — nestled between the 0 and 25% channel lines in this case — almost always ends up being a good fit with smaller scale daily price action.

Wherever I place this smaller channel, the price action of Mar 15 – Apr 5 ends up being an outlier.  That is, there is no good channel fit that captures that bump in the middle — a bump which ended up being a H&S pattern, I might add.

Aside from the lack of a good channel fit, this bump pushed a little beyond a good harmonic fit, too.  After shedding 84.6% of its value between May 07 and Mar 09, XLF didn’t retrace .618, .786 and .886 of its value as did other major indices (it’s still working on .382 at 18.21!)

It hit its high of 17.12 in April 2010, dropped 22%, then climbed back to a new high — and double top — of 17.20 in Feb 2011.  With that as a new high, it proceeded to shed 36% when the rest of the market melted down last year (SPX was down 21.6%.)

Since then, SPX retraced 135% of its drop, but XLF only recently reclaimed 88.6%.  It did so in the traditional manner, reversing big at the .500, less so at the .618, and another one at the .786.  Only, it wasn’t exactly the .786.  It overshot the 15.86 Fib by 15 cents — thus forming the little bump (and H&S pattern) that extended beyond the yellow channel.

BTW, about the same time that XLF reached that .786, SPX was tagging the 1.272 extension of the 2011 mini-crash (from Jul 22’s 1346.)

XLF reversed hard at the .786 in April, dropping to 13.3 in June.  Then, on QE3 day, it climbed all the way — well, almost all the way — to the .886 at 16.49.  It actually came up 5 cents short.

Naturally, it got a reaction, dropping back to 15.06 as the rest of the market slid into Nov 16.  Since then, it has been on a tear — actually tagging the .886 (finally!) on Tuesday the 18th.  Remember, this is the .886 retrace of the drop from 17.20 (Feb 2011 high) to 10.95 (Oct 2011 low.)

Could it be breaking out?  Sure. Breaking the .886 and the 16.44 high was a big deal, and the bulls are emboldened. There are targets just above at 16.75 (white .786), 16.82 (purple .786) and 16.9 (red 1.618.)  And the smaller yellow channel midline is right in there in the midst of all those harmonic targets.  It wouldn’t surprise me in the least if we snagged one or all of those.

But, in the absence of a general market break-out, this could be nothing more than a channel and harmonic overthrow — as happened when it exceeded the .786 by 16 cents last March.  XLF is currently trading — with negative divergence in every time frame — at 18 cents above the .886 at 16.67.

UPDATE:  4:00 PM

Usual last-minute nonsense sent SPX up 3 points at the close, nearing the .707 at 1443.4.  XLF closed at its high of 16.7.  Both are showing negative divergence across the board.

RUT retraced higher than yesterday’s high, but it looks pretty much done at 856.54 — rising wedge back test and .886.

And, check out the daily RSI.  That’s a very nice chart.