The Stupidity and Folly of the Crowd: Your Guide to the Fiscal Cliff

Fiscal cliff, fiscal cliff, fiscal cliff. Those two words are all over the print and electronic media. It is hard to escape unless you are like most Americans and believe that Obama has your back and this is why you voted him. So why worry. Or you just don't know enough to care, so why bother in the first place as you are only a pawn in the bigger game of life. Or you are truly clueless and out of the loop because you spend more time worrying about your overage minutes on your cell phone's data plan.

The current market dynamics are really no different than the lead up to QE3. It was the expectation of QE3 --not the event itself-- that led to the market rise this past summer. Once QE3 arrived, the market sold off even though the announcement of QE to infinity should have been a blockbluster and blown the doors off the market. But it wasn't. It was classic buy the rumor sell the news. So now we have the current crisis of the day. As with QE3, the only reason for the market to go higher is the expectation that the fiscal cliff mess will be resolved positively. And we know that it will….it has to be –that is the expectation – at least until the announcement. Why? Neither political party wants to be responsible for pushing the economy into a recession.

Now by positively resolving the problem, I don’t mean fixing the problem or putting the country on a better path that will resolve the problem. Something of this magnitude can’t be solved with only 3 weeks of planning. By "positively", I mean some sort of scheme/ resolution that will kick the can down the road just a wee bit further.

Of course, all this posturing is very silly because a) we are likely headed towards a recession anyway; b) a recession would actually be good for the markets and economy in the long run but no one wants the pain; c) to lay the blame at the feet of any single entity is goofy such that all it shows is a complete lack of understanding of the complexity of the problems in this country.

So to make a long story short, everything leading up to the actual resolution of the fiscal cliff will be bullish. But the only way to have some sort of bullish mojo is to have a little bit of bearish mojo along the way to set up the bullish push higher. In other words, if they announce today what we already know –that some sort of compromise is forthcoming –then the market wouldn’t have any reason to go higher. There will be buyers under this market like Wednesday morning. This is also consistent with the sentiment data which is bearish (i.e., bull signal) but not too bearish (no real consensus) to suggest a strong snap back. I suspect traders and investors will front run the fiscal cliff announcement like they did with QE3, and with the announcement of the compromise to address the fiscal cliff, the market will sell off like it did with QE3. If the politicians don’t come to some sort of compromise on the fiscal cliff, then we will find out then, but until that time, the expectation is that this issue will be resolved and there is always the hope that it will be resolved.

Lastly and looking out beyond the fiscal cliff, we have the light holiday trading of Christmas and New Year’s, so this is seasonally bullish. Remember, we can’t ruin the holidays. Then we have “the bulls are going to get to work” at the start of the New Year. So even if the fiscal cliff is resolved (which you should expect) and it is received only warmly, there is still hope for the markets come January 1

Once again, the only thing that can derail this scenario is the announcement that our politicians have not struck a deal and we won’t know that until the clock has run out.

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