Market strength belies fiscal, economic weakness

With the prospect of a debt ceiling fight, weak Q4 earnings and fragile technicals, bulls may be in for a disappointment.

By Anthony Mirhaydari Jan 9, 2013 3:38PM

Businessman reading newspaper copyright A. Chederros, ONOKY, Getty ImagesTraders are still reveling in the positive buzz from last week's fiscal cliff deal. But there are signs the good feelings won't continue for long. The looming debt ceiling fight is starting to generate attention, and it's poised to be a whopper with the Treasury set to drain its cash reserves as soon as Feb. 15.

 

There's more. Fourth-quarter earnings could post the first year-over-year drop since the recession ended. The economic data is beginning to disappoint. And yet, Wall Street sentiment and hedge fund positioning is extremely optimistic.

 

The disconnect sets the stage for disappointment, and lower stock prices, in the days and weeks to come. 


Here's why: 

 

Despite all the headwinds we face in 2013 -- the debt ceiling fight, Europe's unresolved debt problem, weak corporate earnings and revenues -- Wall Street strategists are expecting the S&P 500 to gain 9.4% this year. I think that's setting people up for disappointment.

 

In fact, the gap between where the strategists think the S&P 500 should be and where it actually is have increased to levels not seen since just before the August 2011 market meltdown caused by the debt ceiling fight and resultant credit rating downgrade of the U.S. Treasury. 


Before that, expectations swelled before the May 2010 "flash crash" caused by the outbreak of the eurozone debt crisis.

 

 

As for earnings, Barclays Capital strategist Barry Knapp notes that earnings will be dragged down -- particularly in capital spending exposed cyclical groups like energy, technology, and industrials -- because capital expenditures in Q3 was weaker than at any point outside of a recession in 25 years. Overall, earnings are expected to grow just 1% year-over-year, but a pullback in analyst revisions lately suggests that could be too high.

 

Financials are expected to fill the gap (non-financial earnings are expected to fall 1% year over year) but expectations may be too high with layoffs mounting and earnings estimate revisions for cyclicals moving lower recently.

 

At the same time, the technicals are also suggestive of at least a short-term pullback. Just look at the unprecedented drop in the VIX ($VIX) over the last week, down nearly 40% over the last five days. But medium-term volatility has only fallen 24.8%.

 

Translation: Options traders are betting that the market will calm down over the near term before the turbulence returns. This is known as a "steepening of the volatility term structure" as is often seen near major market tops.

 

 

Something similar happened in July 2011 as the market bounded higher in what proved to be a headfake rally ahead of the debt ceiling fight. Then, as now, the term structure steepened.

 

But the current steepening is of a much larger magnitude. That is, short-term VIX has dropped much than in those other examples. In fact, what we're seeing now resembles the kind of market price dislocations seen during panic selloffs -- the last two being the late 2008 meltdown and the aftermath of the May 2010 "flash crash" caused by the Greek debt crisis.

 

 

This brings us back to a point I made in the wake of last week's big market rise: Extreme price volatility, up or down, is a symptom of downtrends. Orderly markets don't suffer from this kind of behavior. And thus, the current market has all the hallmarks of a headfake, short-covering rebound -- albeit an extreme powerful one -- as the economic fundmentals, represented by the Citigroup Economic Surprise Index shown above, roll over.

 

I continue to recommend long volatility positions to take advantage of what's coming, including the iPath S&P 500 Short-Term VIX (VXX) or the Velocity Shares 2x VIX (TVIX).

 

Disclosure: Anthony has recommended both the VXX and TVIX to his clients.

 

Be sure to check out his new investment newsletter, the Edge, and his money management service, Mirhaydari Capital Management. A two-week free trial has been extended to MSN Money readers. Click the link above to sign up. Mirhaydari can be contacted at anthony@edgeletter.c​om and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.  

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41Comments
Jan 9, 2013 6:08PM
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"Market strength belies fiscal, economic weakness"


This has been the case for almost 4 years now.  Our GDP has grown by roughly $2 trillion during the last 4 years.  Doesn't sound too bad, until you realize that during that very same time, we've added $7 trillion to the debt.  This doesn't count the unknown trillions pumped in by Bernanke.  4 years ago, our GDP was roughly $13.6 trillion and the federal budget was $2.7 trillion.  Now we have a $15.6 trillion GDP and gov spending has gone up to $3.6 trillion.  So in 4 years, our GDP is up 14% while gov spending has increased 33%.   We're on our 4th round of QE.  We have less people working now than we did 4 years ago.  And we have more people than ever before directly dependent on the gov for their basic needs.


Stocks have long since ceased being a bellwether of economic strength.  They are currently just a reflection of a devalued dollar, artificially suppressed interest rates and the willingness of the powers that be to prop them up through any means necessary.

Jan 9, 2013 5:02PM
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Lets keep it simple Anthony.  We have been unable to break through 13,700 and the longer we sit here on spin cycle the harder the fall.  We have Economic bombs going off to our left and right.  A trillion plus a year goosing the economy and the fear of getting caught by inflation forces folks into this market. I really  don't see being in this market as anything but a least worst case scenario.  Not a healthy posture in my opinion.  I don't believe we will hold at 12,700 this time and if we don't next stop 11,500.  I have numerous friends and talked to many young people who are now understanding and experiencing economic fear as they never have in their lives.  Yea I agree Anthony but you know as well as I timing is everything in this game.  I feel any upside risk at this time is becoming minimal.  I feel consumer  non necessities such as Cable TV, Personal Electronics, Expensive Specialty Food Stores, and Entertainment are most vulnerable and ripe for a good picking.  I am short MSFT, COST, and CMCSA .  JMHO
Jan 9, 2013 7:02PM
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No kidding! All you need to do is look out the window. My phone hasn't rung and I haven't had a single order since the beginning of Dec.
Now, everyone is missing an extra $20 or $30 bucks a week and everything is going up to cover the added taxes. Electric. Water/Sewer. Food. You name it! Oh! And I forgot, raises for congress. They're not going to take a hit. They will do the same as all the other lazy office toads, and pass the pain onto the working class.
We are feeling it! You better believe we are feeling the pain. The pain of watching the rich buy all new toys and have a great life funning and frolicking while the middle class turns into the poor class and struggles thru supporting the rich classes great lives.

Jan 9, 2013 8:03PM
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VL-on a cost per BTU and energy density evaluation basis, NONE of these phony green energy scams would last another day without subsidies and will contribute to our economic collapse if we keep funding them at current levels. If they cant pay their own way, cut them off and leave it to scientists and engineers to bring the new clean energy. The political favoritism and pork in these programs assures their failure.
Jan 9, 2013 7:49PM
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I think it is foolish to equate market fluctuations with overall economic conditions. QE programs, giveaways, phony green jobs, tax and regulatory policies, low workforce participation regardless of unemployment numbers, layoffs planned for 2013 already announced well into 6 figures and counting, government debt, unfunded pensions, states debts, etc all conspire to collectively make for a wary consumer, 70% of our economy, and baby boomers slipping past peak spending years.

Traders and computers, especially with lower trading volume, are moving the market, especially since most retail investors have pulled out recognizing the market as a casino with the odds against them.

I believe only long term job creation, especially in manufacturing for export, are the real story when assessing where we are and where we are headed. The bill for all that counterfieted money and government giveaways will come due as that is seed capital sucked out of the economy and transferred to non productive applications.

With all the stimulus we are still in a recession and likely to see it get worse. As a small individual investor, I only have a small amount in some small cap energy companies that I believe will be takeover companies at some point. Other than 401s with matching amounts, I advise family and friends to hoard cash at the risk of erosion due to inflation, you want lose it all like you can in the market.   

Jan 9, 2013 7:51PM
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Next time up is right.  The prevailing feeling I've seen in others for over four years has been economic fear.  The actions of our elected officials and media coverage have been prime building blocks in creating this emotional disease in the people of this country.

 

And we still don't know what their motivation is.  I fear we will learn some day soon.

 

 

Jan 10, 2013 10:48AM
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The ONLY REASON the DOW is up is due to the manipulators in control of the market and a heavy dose of government intervention.  If there was no QE injections of money etc. the DOW would be below 10,000.  It is all nothing more than "smoke and mirriors" and those who control the stock market are licking their chops all the way to the banks who are TBTF.  Wall St is nothing more than legalized gambling run by "Bookies".
Jan 11, 2013 7:07PM
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We take a day like today any day of the week, twice on fridays....Flat to a bit up, beautiful...Scumbags left today in a bit of a foul mood; after monday and tuesday they thought this would be their week, especially after last one...Oh well...One for the good guys....We have to take it easy though, there is always next week and more and more earnings coming...Have a great weekend all.
Jan 9, 2013 7:31PM
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You mean the international economy is strong and reflected by the market.  The US economy is stalled because of the burder of government.

Jan 11, 2013 11:14AM
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No big surprise down here after the opening bell; after the last couple of days crooks not in a very good mood and started doing their thing early...Why? Because they can, because its friday and because they outnumber us all today...Well, still a long way to go, never give up. Be cautious though, more later.
Jan 10, 2013 10:12PM
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Nice last 90 minutes today, buyers came in and tilted the scale...Manipulators not too happy of course...Oh well, too bad for them...They always have tomorrow...Nice little rally though.
Jan 10, 2013 12:13PM
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Do not get too excited about the futures being up and opening up higher...Yes, we are 45 points up or so but things do not look that peachy down here...Plenty of manipulators ready to react and a few minutes ago at approximately 1030 hrs they called for the first wave of selling...Be cautious, we may be in the red soon....One more time, its worth repeating, we are so glad the markets and the economy are not strictly correlated, the Dow would be up 5000 if we were lucky...More later.
Jan 9, 2013 9:06PM
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Downturns are based on fear, we have fear. Here we go.
Jan 14, 2013 12:55PM
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We've been hugging the flat line for most of the morning, how long will this last...We will see....The arrogant marxist is speaking once again, lying to the American people as usual telling us the economy is roaring; what planet does this fool live in???.Opens his mouth and lies....So sad. America will pay the consequences of reelecting this marxist bastard..Actually, we are already paying them.
Jan 14, 2013 8:52PM
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We ended the day basically flat, a bit down, we'd take it any day, especially after the village idiot opened his trap once again and lied to the American people saying the economy is roaring...Oh well, we are used to this arrogant ignorant buffoon talking garbage...The biggest debt creator in American history as usual blaming the Republicans...Like we always tell you, he may fool the people, he doesn't fool Wall Street....We will see what happens tomorrow...Hopefully a bit better than today.
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To Anthony & all; how will a flash crash or major sell off state side effect China's economy?
Jan 9, 2013 6:57PM
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We were able to hold nicely today, maybe not 90 but we take 61 any day of the week....Scumbags fell short...Will not get any easier tomorrow though...We are sure manipulators will come out swinging...We shall see.
Jan 10, 2013 12:01AM
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Within my Mantra of Gambling....Went to the Casino Sunday nite, to watch the Big Game on 2-3 big screens...

If you have ever played Mississippi Stud poker, you will understand.

Miss Lilly while waiting for a table to open put $10 bucks in a slot and picked up over $340 in about 20 minutes..

I went and played BlkJk with some match or "free play" of about $20 per hand..Lasted about a half hour, but only lost about $15.

Then onto Missippi Stud...4th hand in game, had two 8s(dealer throws up 3 common cards)...

I went all in with the ante and 3 cover bets, with total out of $50 bucks..

A pair of 8s are a push (can't lose)..Dealer turns first two cards like the turn and the flop in Hold'em.

They were both 8s....4 of a Kind, pays 40:1.......I didn't need the River.

     After leaving we stop at a Vets club in home town, gonna buy a couple drinks...Wife steals 20 bucks out of my change, plays pull tabs...Gets top prize out of machine of $200 and about $23 of other winners...Yes we bought a few friends, drinks....

It was a damn good night, better then most....BUT the "RollTide" whipped the "The Irish"....

Now if Wall St....Only knew how to deal "Good Hands"..........?

 

 

Jan 9, 2013 11:24PM
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13,700 range on the DOW hasn't been seen since about the EOQ last Sep/Oct...

 

We can D&G this all you want hoping that if you say it long enough or repeated times it may come true?  The "major correction" that many of you think or ramble about.

Yeah that can happen sooner or later....Then we will all pat each other on the back and say we were correct..High-fiving yourselves into a depression or a negative mindset...

If you are all sitting out on "sideline cash", why do you even give a fk...

Are you only wishing misery on others; Just to bring them down to Your Level....??

With earnings season just kicking off....I guess I would hold my projections until we get a better handle on whether the money and money flow is good or bad?

 

If the Companies come in with Great earnings or revenues, you pick a bad reason why they got there...If they aren't so good...IT'S a "I told you so.."

So you can sit on cash and cry or maybe you can invest in a decent Company trying to make it the hard way.....BECAUSE THEY EARNED IT.

Jan 9, 2013 11:27PM
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Bite this 40, Wyatt or Steve......
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