Assuming Away The Can

Daily State of the Markets
Wednesday, December 5, 2012

Good Morning. Three men are stranded on a deserted island with nothing to eat but several cans of beans. Unfortunately though, our castaways have no utensils and no tools. The question, of course, is how are the men going to eat the beans without a can opener? After a while, hunger sets in and the three men begin to attack the issue in earnest. The first man, an engineer by trade, proposes that the group build a can opener out of rocks and sticks. The second man, a scientist suggests that they heat the can of beans to an extreme level, which will eventually cause the can to explode – and while a bit of a mess, the beans would indeed be available for consumption. And the third man, an economist, responds with, “Gentlemen, the solution is simple. Let’s just assume away the can and eat the beans.”

I relay this age-old yarn, which, by the way, is really only funny to those who have spent time studying economics, because in my analysis of the current market environment this morning, I am going to essentially assume away the can and eat the beans.

Unless you’ve actually been stranded on a deserted island, you undoubtedly know that the stock market is being driven currently by expectations for a resolution of the fiscal cliff. I don’t know about you, but I am already tiring of the algo-driven reactions in the market every time one of the two parties sneezes in public. So, while I suppose I could talk about the expected outcomes or offer an opinion on the extreme positions on both sides this morning, I thought it might be more constructive to put the cliff aside and take a look at what our market models are telling us at the present time.

As I’ve opined a time or twenty, if you can get the overall market environment right, your chances of staying in tune with the primary trend improve greatly. And this is what I’ll be attempting to do this morning via a review of one of my bigger-picture market models.

My assumption is (and as a quick caveat, we all know what happens when you assume, right?) that the overall environment will eventually hold sway in the market – once the cliff is resolved, that is. So, let’s get to it.

A while back, I introduced my revamped “weekly environment model” which is designed to take the temperature of the overall market environment once a week. The model has 10 components and includes everything from trend, momentum, cycle, economic, sentiment, and monetary indicators as well as almost everything you can think of in between.

The idea is to assign each component indicator a score of +1 for a positive reading, 0 for a neutral reading and -1 for a negative reading. We then sum the row to come up with an overall model score. Anything above a composite reading of +3 indicates that the odds favor the bulls while anything below -3 suggests that the bears are large and in charge.

So let’s run it down. Our breadth indicator is positive. As is the cycle outlook, the volume relationship, the short-term trend, and the technical health of 105 industries. The bears should take note of the fact that none of our 10 component models are negative and that five of the models are neutral. As such, the overall model score is +5 this week.

According to my buy/sell strategy for the model, this means that one should be long stocks at the present time. And following the signals this year would have produced a gain of +19.02% so far, which certainly isn’t too bad. More importantly, the model has gotten the big moves right as it said to be long stocks from Jan 1 through April 16th then stepped aside basically until June 25th, when it said to get long again. The model then sold to cash on 10/1 and then got whipped in mid-October before suggesting that it was safe to enter the water again on 11/26.

In sum, it is quite clear that the state of the fiscal cliff will dominate the market action until resolved one way or the other. However, my longer-term market model, which effectively assumes away the can (the news flow) and eats the beans each and every week, is currently saying that while cliff worries are warranted, the environment is actually not bad – well, for this week anyway.

Turning to this morning… Comments out of China’s new leadership suggesting that additional stimulus spending could be forthcoming lifted Chinese markets overnight. Across the pond, the Eurozone Services PMI report came in above expectations. So, with the overnight markets green across the board and more Fiscal Cliff meetings on tap today, the U.S. futures are pointing to a higher open in the early going.

On the Economic front… We will get ADP Employment, US Productivity and Unit Labor Costs, ISM Non-Manufacturing, and Factory Orders this morning.

Thought for the day… Do what you can, with what you have, where you are. -Theodore Roosevelt

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell…

Major Foreign Markets:

• Shanghai: +2.88%
• Hong Kong: +2.16%
• Japan: +0.39%
• France: +0.32%
• Germany: +0.28%
• Italy: +0.34%
• Spain: +0.20%
• London: +0.20%

Crude Oil Futures: +$0.26 to $88.76 !========>!========>