Time for optimism?

Research suggests the market is pricing in too much recession risk from the fiscal cliff. If so, stocks are a bargain.

By Anthony Mirhaydari Nov 19, 2012 4:39PM

Image: Stock market Traders (Photodisc/SuperStock)By all indications, the rebound rally I've been expecting kicked off on Monday in a big way. The entire "risk-on" complex of stocks, commodities, and risky high-yield bonds is launching higher while safe haven trades like the U.S. dollar and Treasury bonds are suffering. Traders, it seems, are suddenly feeling more optimistic after Friday's fiscal cliff negotiations in Washington went rather smoothly.


While Democrats and Republicans still maintain large disagreements on things like taxes, both parties seem to be moving towards common ground. The most important of which is that a temporary extension of the $720 billion worth of tax hikes and spending cuts set to hit on Jan. 1 -- giving lawmakers more time to hash out a comprehensive deal.


As a result, Wall Street is beginning to realize they've been too pessimistic. And as a result, the buying pressure is on and is set to continue.


On Friday, Senate Majority leader Harry Reid said Congress and the White House would not wait until the last day of December and could agree on a deal framework prior to the deadline.


Republicans seem willing to countenance tax increases in exchange for spending cuts and entitlement reforms backed by a legal structure to ensure the cuts are made.


Moreover, there is also progress over in Europe. There are reports that eurozone officials are going to indicate tentative approval for releasing Greece's next eagerly awaited bailout disbursement of €44 billion. And officials from the European Central Bank appear to be warming to the idea that Greece, because of its persistently weak economy, will likely require a third bailout program.


Investors weren't expecting this turn of events. JPMorgan strategists note that the drop in stocks have priced in a 40% probability of a fiscal cliff caused recession which, in their words, "is too high for us."


But what of the risk that President Obama leads a charge on raising capital gains and dividend rates on investors? JPMorgan separately notes that tax-sensitive U.S. households likely hold only 13% out of $24 trillion in U.S. corporate equities outside their retirement accounts. Tax-insensitive investors, such as hedge funds, pension funds, and offshore entities, are the more probably marginal buyer of American stocks.


And they are largely unaffected. Indeed, they find no historical evidence that capital gains of dividend tax changes alter the investment patterns of retail investors or the payout policies of non-financial corporations.


All of this sets the stage for an end-of-year Santa Claus rally fueled by a newfound cordiality in Washington combined with the rising likelihood of another dose of cheap-money stimulus from the Federal Reserve at its December policy meeting.



In response, I continue to recommend clients focus on areas including silver, crude oil, and related energy stocks including Marathon Petroleum (MPC), which I am adding to my Edge Letter Sample Portfolio. Valero Energy (VLO), shown above, is also doing very well.


If you're looking for quick and easy exposure, consider these three exchange traded funds: The iShares Russell 2000 (IWM), the iShares High Yield Corporate Bond (HYG), and the DB Commodities Tracking Fund (DBC).


Disclosure: Anthony has recommended MPC, HYG, IWM, and VLO to his clients.


Be sure to check out Anthony's 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.

Nov 19, 2012 6:08PM

On hope?...


 Yes the hope from big investment houses that the sucker and chump factor still shows signs of life...


  Just wait for the sell off either tomorrow or Wednesday.

Nov 19, 2012 6:05PM
The stock market is only one indicator of the economy, and a flawed one at that since it is fueled more by emotion than by productivity.  Politicians throwing more money into bottomless pits doesn't fix anything.  Increased capital gains taxes could hurt the stock market, but corporations have not been expanding nor adding jobs so whether investors throw money at them or not makes no effect.  Sure we'll have a "Santa Claus rally" because people will sacrifice to buy gifts, but it will be short-lived and then followed by a downturn as merchants cry that they didn't get enough. 
Nov 19, 2012 6:05PM

Anthony,  I guess facing yourself in the mirror every morning is still not an issue.  Take your advice that's channeled through your corporate sell side masters and shove it up your rear.  Folks, this is a short covering squeeze so that all the margin called hedge funds and primery dealers can get a better exit point by year's end.

Nov 19, 2012 6:03PM
Isn't there some short covering going on?  I believe the Dow was in correction territory.
Nov 19, 2012 6:02PM

I'll just stick to plumin........I'll be fine


Nov 19, 2012 6:00PM
And when they kick the can down the road another year. Dow one million. Cause its just that valuable.
Nov 19, 2012 5:53PM

Mir - ha - ha - ha - ha - ydari. Don't trust him. Don't believe him. Don't have anything to do with him.


Wall Street is a mess. They so want your money so bad that they have priced in everything. The next terrorist event? Priced in. Buy. Buy. Buy. The European debt (sovereign and fiscal) crisis? Priced in. Buy. Buy. Buy. The "Fiscal Cliff" thingy? Up or down: all priced in. Buy. Buy. Buy. Capitialism? All priced in. What Capitalism? Capitalism is dead. Buy. Buy. Buy. Free Market Economy. What Free Market Economy? All priced in. Either way. Up or Down. All priced in. Buy. Buy. Buy. Get the idea?


Nov 19, 2012 5:29PM
Well I just got back into the market last week during the low point.  Time to make some money this week again. 
Nov 19, 2012 5:02PM
This rally is not based on the economy getting better. Nothing has changed except stupid investors think because politicians stood on the white house lawn and said they think they can get along and make a deal on the fiscal cliff, all will be set right. I  say BS! That socialist Pelosi can't get along with anyone, so how can anyone throw their money into the market based on the hope that these politicians will solve anything? They'll just kick the can down the road and keep on spending. The only difference is they will beat up those making 250 grand or more to raise 9.4 billion (less than 1%) toward a yearly deficit of 1.1 trillion and growing. Like that's gonna create a lot of jobs and help the economy!
Nov 19, 2012 4:54PM
Tony baloney..at least the weatherman is right half of the time..
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