Fiscal Cliff Not Only Threat

12/3/2012


A one-week bounce has given way to choppy trading, with mostly good news on the U.S. economy countered by worries regarding corporate profits, the fiscal cliff, and a fragile global economy. The Dow Industrials are more than 6.5% above their June low of 12,101.46, while the Dow Transports are roughly 5% above their June low of 4,847.73. A breakdown below those points would be bearish, while a rally above this year's respective highs of 13,610.15 and 5,368.93 would be bullish.

Because both averages staged notable bounces from mid-November lows (12,542.38 on the Industrials and 4,891.27 on the Transports), a breakdown below those points would be discouraging. For now, as a partial hedge, we are holding about 10% to 15% of equity portfolios in a short-term bond fund.

Earnings slowdown

Speculation regarding the fiscal cliff is getting most of the credit for the market's zigs and zags, with stocks rising after politicians suggest a compromise can be reached — and slumping on indications the Dec. 31 deadline to avoid automatic tax hikes and spending cuts will not be met.

While this pattern seems likely to continue in the near term — and there is no doubt that U.S. growth will slow if the full impact of $600 billion in tax hikes and spending cuts takes effect in January — investors should not attribute all the market's action to the fiscal cliff.

Stocks have been under pressure since third-quarter earnings season began. Negative preannouncements outnumbered positive preannouncements by a nearly 4-to-1 ratio — among the worst on record, according to Thomson Reuters. Earnings for the S&P 500 Index are expected to be up 4% year-to-year for the fourth quarter, down from the 10% growth that was anticipated on Oct. 1.

While third-quarter results were skewed lower by big declines in the material and energy sectors, five of the S&P 500's 10 sectors are expected to post profit declines for the fourth quarter. Moreover, there is no denying that growth has slowed for the typical U.S. company. The median S&P 500 company delivered year-to-year growth of 4.6% for per-share earnings and 4.5% for sales in the most recent quarter.

Conclusion

While speculation regarding the fiscal cliff is likely to dominate stock-market commentary in coming weeks, the averages are always discounting everything that could impact share prices. With both the Industrials and Transports within striking distance of important points in both directions, we intend to watch the averages closely.


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