A Tumultuous End to 2012

Another year is coming to a close as everyone winds down for the holidays and prepares for the New Year.

The last few weeks of the year are traditionally quiet ones for investors…

The bigwigs and aggressive traders are on vacation for the holidays, leaving a handful of relatively inexperienced traders with the reins. Normally, this means the markets will skate through the end of the year.

However, 2012 has hardly been a normal year — and its end will be no different.

A couple of factors are teaming up to remove any reprieve investors might expect.

News is surfacing that traders won’t be taking much time off, if any. Firms simply see too much risk within the next couple weeks.

According to J.J. Kinahan, chief derivatives strategist at TD Ameritrade in Chicago, “A lot of firms are saying to their trading desks, ‘You can take days off for Christmas, but you are on standby to come in if anything happens.’ This is certainly different from previous years, especially around this time of the year when things are supposed to be slowing down.”

The Elephant in the Room

The fiscal cliff issue is the dominant factor here. There are some signs of a thaw in the standoff, but not enough.

Moving forward is great, but progress alone won’t cut it. This is a timed race… and we’re far from the finish line.

While House Leader John Boehner has agreed to a tax increase limited to those earning over $1 million. President Obama has reformed his $250,000 threshold to $400,000. Boehner also edged closer to the White House proposal by putting up to $1 trillion of new revenue on the table, compared to Obama’s figure of $1.2 trillion.

Meanwhile, absolutely no ground has been made on targeting specifics for the entitlement cuts desperately needed to have any real effect on the long-term deficit.

Without any progress on this front, the rest of the deal is practically useless.

So far, Obama has offered about $400 billion in 10-year entitlement savings, mostly through small adjustments in reining in health care costs.

While Republicans have touched the so-called “third rail” of social and medical spending, there is no way they are going to go public with anything groundbreaking — unless Democrats jump in with their support.

The clock is ticking, and there are just a dozen days left to bridge the wide gulfs in ideology within what will go down as one of the most partisan bodies of Congress in U.S. history. 

We can all hope a compromise isn’t far off… but it would be foolish to bet on it.

Corporate Cuts

The fiscal cliff issue is closely related to another major concern for traders: Corporations are already looking to make cuts for 2013 that match or exceed the pullback we’ve seen in this quarter.

Expenditures by Standard & Poor’s 500 Index companies will fall 1.3% in 2013 after three years of growth, according to more than 10,000 analyst estimates compiled by Bloomberg.

The last time capital spending declined was at the end of 2008. That was right before stocks slumped to a 12-year low.

While the S&P 500 has risen 109% since in March 2009, it is poised for the first fourth-quarter decline since 2008. U.S. stocks had the worst performance among 24 developed equity markets this quarter.

It isn’t clear where things will go from here, due to mixed signals. The S&P 500 is already trading around 12% below the average profit to earnings ratio at 14.4 times. At the same time, options prices show the most bullish outlook for the S&P 500 in the last two years.

Beware Friday

Speaking of options, you should keep a close eye on your investments on Friday. While everyone is gearing up for a long holiday weekend, four events are lining up that will cause volatility…

Traders call it the “quadruple witching” day because, as the third Friday of the last month of the year, contracts for stock options, single stock futures, stock index options, and stock index futures all expire.

The effects are not limited to options and futures traders; mandatory share shuffling will happen. It is expected, but there is no guarantee it will happen in a vacuum.

Any lack of progress in fiscal cliff negotiations by Friday will dramatically raise the stakes for traders. Fingers will be hovering over the “sell” button, and there is no way to tell in real-time if a drop in share prices is just volatility, or the beginning of a run. And that leaves selling the only sensible way to protect assets.

This makes Friday a dangerous day to be distracted by shopping, wrapping, and baking…

Looking Forward

Regardless of how the fiscal cliff fiasco pans out, the dust should begin to settle within a couple weeks. Neither party can suffer through another hit to their already abysmal credibility.

Investors may choose to sit on the sidelines for now, and it’s hard to blame them.

Our advice is to not get stuck on the current issues. It’s time to start planning how we’ll play the market going into 2013…

Our editors have been gearing up for the New Year — and have some strong trades lined up for our readers.  

Wishing you and yours a happy, healthy holiday…

For Your Prosperity,

Adam English
for Wealth Daily