Daily State of the Markets

Four Ways To Play The Cliff Game

In case it is not blatantly obvious by now, the current market driver is anything and everything relating to the state of the fiscal cliff. And at this point, we can even identify how much a good or bad comment on the status of either party’s position is worth to the market. You see, one of the things we’ve learned this week is that any comment from a ranking politician on the outlook for the negotiations is good for a move of about 6-8 points on the S&P 500 (approximately 0.5%) within about 5 minutes.

Thursday was a perfect example of this as the S&P dove from 1416.50 at 11:39 am eastern to a low of 1409.04 at 11:43 am in response to House Speaker Boehner saying that the Democrats were comfortable “going over the cliff.” Granted, the market soon recovered as the humans actually listened to the rest of the comments and recognized that there wasn’t anything new being relayed by the Speaker. But the bottom line is that this is what is happening in the market right now each and every time a politician steps to the microphone.

I don’t know about you, but I am growing weary of this news-induced, algo-driven “game” that passes for the stock market these days. This isn’t sour grapes either, because I’m actually long right now and am enjoying the current jaunt higher. And I completely understand that there an awful lot of milliseconds in a day and that a trend following strategy applied by the lucky few who have world class data feeds and computing power is a great way to play the game. But come on, does the market really need to move 0.5% every time somebody opens their mouth in Washington?

I also understand that the old Wall Street saw “Panic early or not at all” is being applied here at light speed. But it is vital to understand that the political gamesmanship going on in Washington day in and day out doesn’t necessarily impact the end result here. This isn’t a situation where each new piece of information incrementally helps develop a picture of what the endgame will be. No, what we’re seeing is a prolonged period of negotiations via the press. And in short, there will either be a solution in the next 32 days or there won’t. It’s that simple.

As such, there are a few ways one can choose to play the “cliff game” – without the benefit of a supercomputer. The first option is to go on vacation for the next few weeks. Remember, these negotiations, which happen to rock the market at every turn, aren’t likely to end quickly. Again, there is virtually no incentive not to drag this out until the “Cliff clock” strikes midnight. This is just the way Washington works.

A second option is to just keep on keepin’ on with your market strategy. This will be my weapon of choice as I don’t see a need to adjust my systems here. Eventually this mess will be cleared up. And eventually the market will embark on a meaningful move. Therefore, I’ll go ahead and follow my systems assuming that the next meaningful move isn’t that far off. But that’s just me – it’s the way I prefer to approach almost all market environments.

But if you want to actively participate in the “cliff game,” the first step is to place your bet on which way this thing is going to turn out. If you look at the glass as half full and assume that the boys and girls in Washington really have learned their lesson this time and that they really will do what’s best for the country by coming to some sort of bipartisan agreement before the end of the year, you should implement a “BTFD” strategy. Each and every time a politician gives the quants a reason to push the market around by half a percent, go ahead and “buy the freaking dip.” And then once the market has recovered, go ahead and book the gain.

Why not hold your longs for a while, you ask? In short, because investors may be “buying the rumor” right now as most analysts believe that the cliff situation will be resolved before the end of the year. So, this outcome may be being baked into the cake right now. Therefore, the news of a cliff resolution could very well be met with a “sell the news” approach.

Conversely, if you find yourself in the camp that believes the economy will indeed go over the cliff, then you should be putting on a few more shorts each and every time some politician sends stocks up 0.5%. But unlike the glass-is-half-full crowd, you will want to play for the end game. You want to get enough shorts put on so that when the announcement of the cliff dive finally does come, you will be positioned for the likely temper tantrum the market throws.

As I’ve said, I personally am not going to play the game. I’ll just stick to my strategy and wait for the next meaningful move. But I did want to lay out a couple different alternative approaches to the game for those “players” out there. Best of luck to everyone.

Publishing Note: I have an early commitment Monday morning and will not publish a report. Daily State of the Markets will return on Tuesday.

Turning to this morning… Some improved data in Japan, word that German lawmakers approved the latest Greek bailout, and improved sentiment toward the fiscal cliff all have contributed to modest gains in overseas markets and a reversal in U.S. stock futures. Recall that the futures moved lower after the close yesterday in response to the President’s first Cliff proposal, which included $1.6 trillion in new taxes, $50 billion in new stimulus spending, and new powers to increase the debt ceiling without Congressional approval. However, neither the proposal itself nor the Republican’s response appears to be being taken too seriously at the present time as U.S. futures are currently moving up a bit in front of this morning’s data.

On the Economic front… We will get the reports Personal Income and Spending and Chicago PMI this morning.

Thought for the day… If you’ll not settle for anything less than your best, you will be amazed at what you can accomplish in your lives. – Vince Lombardi

Positions in stocks mentioned: none

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder and Chief Investment Strategist
StateoftheMarkets.com

P.S. f you are looking for a rules-based system to help guide your market exposure, check out The New Daily Decision Service. To learn about the Daily Decision, Click Here to watch Dave M. walk you through the service.

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David Moenning is a the Chief Investment Officer at Heritage Capital Management. Dave is also the proprietor of StateoftheMarkets.com, which provides free and subscription-based portfolio services. Dave began his investment career in 1980 and has been an independent money manager since 1987. Thus, Dave has been live on the firing line and investing for a living for more than 25 years.