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Seasonal Rallies and Fiscal Cliffs
Flexible Plan Investments
By Jerry Wagner
November 27, 2012

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Black Friday—that term used to be reserved for days that major crashes began in the stock market. Fortunately, we saw anything but last week as stocks soared to their best week in months. The market followed through once again on the pre- and post-Thanksgiving positive seasonality pattern that we reported on last week.

This week, seasonality suggests a pause before igniting for a final year-end romp. If you are not in a strategy that has equity exposure, this could be a last year-end buying opportunity. Of course, this opportunity is only suggested by past seasonality trends. Neither the rally nor the pause may occur. Here’s why this year the end of November pause may not play out:

Staying with the seasonal theme for a moment, the Thanksgiving pattern was even stronger this year than normal. In fact, last week’s Thanksgiving week performance (3.62% on the S&P) was the third best in history. And when the stock market is up more than 2% during Thanksgiving week, it averages a return of almost 3% for the rest of the year.

Second, the market was very oversold heading into last week, both in terms of the extent of the decline and its length. All ten S&P 500 industrial sectors were oversold and now have moved at best to the neutral area.

Source: Bespoke Investment Group

And the length of the downturn that created that condition had already matched the number of trading days in the last correction (42).

Source: Bespoke Investment Group

Finally, there has been a great deal of talk about the fiscal cliff and most has revealed an awareness of its danger and a palpable desire to deal with it in Congress and the White House.

With all of these factors coming together and still negative investor and advisor sentiment, a runaway year-end rally is a real possibility. (See my comments last week about the dangers of a single strategy market timing approach for your portfolio.)

Still, as we have repeatedly commented regarding the efforts in the European Union to solve their crisis over the last year and a half, all we’ve had on the fiscal cliff so far is talk. And most of that seems to focus on increasing revenue, which we demonstrated last week is not the real problem. The problem is spending.

In a strange and ironic twist, revenues, which are best increased by economic growth, are being proffered as a substitute for the sequestration (read, reduction) of spending on defense and entitlements. And no real spending reductions (only reductions in the rate of spending growth) are being offered in return.

The pound of flesh that the Democrats are seeking as evidence of the President’s “mandate” is increasing taxes by the amount of the Bush-era tax cuts applicable to just those taxpayers jointly making $250,000 or more. According to Congressional Budget Office reports, this would generate about $85 billion in additional revenues next year to either reduce the more than $1 trillion projected deficit, or fund the government for eight days.

The Republicans, searching for a face-saving way to back away from their “no increase in taxes” pledge to their constituents, say we need to reform taxes. They think their “best” reform is to cap deductions for the wealthy. Again, a revenue raiser, but it, too, can only generate a fraction of the funds necessary to balance the budget. Not to mention the effect it would have on fund raising by charities and non-profits.

Even if it were enough to generate the same $85 billion in revenues, it would only reduce the annual deficit by less than 8% and the total $16 trillion national debt by 0.85%. The problem with focusing only on the revenues, and then only on the wealthy, is that even if you taxed 100% of the income of those making $1 million or more, it would only fund the government for 88 days (2010 are the latest numbers available for this analysis).

The amount generated could not even eliminate the annual deficit, let alone contribute to the reduction in the national debt. Even if we also somehow balanced the budget, a 100% tax on million-dollar-plus incomes would take twenty years to pay off the national debt, if all those millionaires retained their citizenship.

Of course, no one would suggest a 100% tax, but this just illustrates the difficulty Congress and the President face. They have to deal with spending and/or they have to increase taxes on more than just the wealthy to make meaningful progress. My bet is that they pass something, and declare, with the media’s help, victory – the crisis solved. Then the markets will tell us whether it was meaningful or not. I hope for the former but have serious doubts.

In the meantime, it is the end of the year, a market bottom may have been formed and, after a pause that is likely to simply refresh, we hopefully will enjoy a year-end rally with green lights and no black Fridays.

All the best,




(c) Flexible Plan Investments



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