At Least They’re Talking, Right?

Daily State of the Markets
Tuesday, December 4, 2012

Good Morning. In my humble opinion, there were three key drivers to Monday’s action in the stock market. Unfortunately for anyone long stocks though, the lone positive came before the opening bell rang while the other two were negative and wound up dominating the session. To be sure it was another day where the machines controlled the action. However, the upside is that I don’t think the alogs are interpreting the way the fiscal cliff game is being played out in Washington right now.

Before I begin, let me state that I am well aware of the fact that markets are NEVER wrong (people are). And I am certainly not going to suggest that the market was wrong yesterday. No, I am simply saying that there is a chance that the subtleties of the current fiscal cliff negotiations may not be being fully appreciated by the bots.

Before the bell Monday morning, stock futures were pointing to a pretty decent open. And indeed, the S&P did pop up about 0.5% in the first three minutes of trading. The move up was attributed to (a) the fact that Angela Merkel had publicly mentioned the possibility of writing down some of Greece’s debt in the future (because there really isn’t any other option) and (b) the general consensus that a cliff deal is going to get done.

As is usually the case, stocks went the other way after three green bars on my one-minute chart. This didn’t surprise me much because I know that there are trend-following algos that will “ride a trend” for a few minutes and then automatically reverse (remember, there are a lot of milliseconds in 3 minutes!). However, after the ISM Manufacturing Index came in much weaker than expected, the algos knew what to do and the early gains began to disappear in a hurry.

Given that Superstorm Sandy had likely affected the data and that Markit’s final PMI for November wasn’t half bad (52.8 vs. the preliminary reading of 52.6 and October’s 52.4), I figured it wouldn’t be long before somebody told the programmers that the ISM headline on ISM wasn’t as bad as it looked. And while the market did rebound a bit, the ensuing rally only lasted about 20 minutes.

From there, the final driving issue took over and it was “all cliff, all the time” for the remainder of the day. While everybody likely recognizes that there is going to be a fair amount of public posturing as well as some negotiating via the press, and most folks do believe some sort of deal will get done, it is fairly clear that the algos continue to respond to each and every headline.

For example, the headline from ABC’s “OTUS” Blog: “Republicans Considering Doomsday Plan if Fiscal Cliff Talks Collapse” certainly attracted some downside selling pressure. Talk about a blockbuster headline for the data mining machines! I mean think about how the computers must have dealt with a single headline that included the words “Cliff Talks Collapse” and “Republicans Considering Doomsday Plan.” Even I would be able to program an algo for that!

While there wasn’t much more than a great headline in the post, it made people think about the possibility of a deal not getting done. And from there, almost every little 2-5 minute rally was met with sell programs.

Next up, the Republicans finally responded to Obama’s first volley. Via a letter to the White House, the new proposal included $800 billion in new tax revenue, $300 billion in discretionary spending cuts, $900 billion in mandatory spending cuts, $200 billion savings from revisions to CPI, and $600 billion from health programs. The market’s initial response was a quick pop up due to the fact that the Republicans appeared to be participating in the game.

However, the White House quickly responded by saying that the Republican Fiscal Cliff plan includes “nothing new” and that Obama was unwilling to give up his demands for tax hikes on wealthiest Americans (because it is indeed the wealthy that got us into this debt mess, right?). So, given the quick and testy response from the West Wing, more selling ensued. And once again, it was concentrated in short bursts, which suggests that it was algo-driven.

The good news is that while the algo’s may be programmed with all kinds of artificial intelligence and hundreds of trading strategies – all intended to play Wall Street’s game at the speed of light – I’m not sure the whiz kids behind the code are well schooled in the nuances of the games played on Capitol Hill.

From where I sit, key number one, which isn’t likely programmed into anybody’s stock trading algo, is that both sides are talking. This is a good thing. Key number two is that the Republicans didn’t counter with the well-worn plan from a year ago. Unlike the President, they didn’t just toss the Ryan plan back. No, Boehner appears to have come back with a plan that bears some resemblance to a plan offered to the Congressional Supercommittee in November 2011 from former Clinton Chief of Staff, Erskine Bowles.

Granted, Bowles immediately issued a press release saying, hey, that’s not the Simpson-Bowles plan. But the key here, which again is unlikely to be appreciated by the algos or the math geeks writing the algo code, is that (a) the two sides are talking and (b) there is still time on the fiscal cliff “clock.” So maybe, just maybe, the programmers will figure this out one of these days.

Turning to this morning… With little in the way of important news and/or economic releases overnight, stocks will likely spend the day focused on the state of the fiscal cliff negotiations. Note that Bloomberg has announced an interview with President Obama at 12:30 eastern.

On the Economic front… There are no economic releases scheduled for this morning.

Thought for the day… Life is 10% what happens to you and 90% how you handle it.

Pre-Game Indicators

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

Major Foreign Markets:

• Shanghai: +0.78%
• Hong Kong: +0.15%
• Japan: -0.28%
• France: +0.74%
• Germany: +0.32%
• Italy: +1.11%
• Spain: +0.47%
• London: +0.01%

Crude Oil Futures: -$0.80 to $88.29 !========>!========>