Happy 2013 and a look at the markets for the year

Happy new Year to all of our readers !!

We entered 2013 on a cliffhanger, but as expected, Washington came to some half-baked deal as time was running out. Markets have gone up, the S&P has gone up 6% since the fiscal cliff deal, and the VIX has fallen to the 13 handle from 23 in a matter of days. Although macroeconomic news from China and Europe are not bad, headwinds certainly persist.

In the US, the fiscal cliff deal turns out to be half-done at best. Spending cuts are absent in the deal, and the political establishment seems to be digging in to the next fight in Washington – raise the debt ceiling in return for spending cuts. This battle is looming in March. The last time such a battle was waged, the markets dropped 15%, and the VIX spiked to 48. But, for the month of January and the first half of February, I think we can expect a choppy move that grinds slowly to the upside, perhaps to the 1500 level. But as the fiscal cliff negotiations have clearly shown, Washington is unlikely to come to a deal until the bitter end as both parties are suggesting they won’t compromise, and we could see the market dropping 5 to 10% in the period leading upto any deal. With the VIX at 13 levels, it may be prudent to buy portfolio protection this month, and be ready to not only blunt losses by hedging, but also to make money on the hedge itself.

In the larger scheme of things, 2013 could be a pivotal year in the markets. This is because millions of traders and investors are watching the 20 year chart of the S&P 500, and the massive Head and Shoulder pattern that’s forming. Of course, technicals can only drive the markets in the absence of fundamentals, but this one could be a bit different – it is such a long term pattern and it is playing out textbook style. Looking at the 20 year SPX chart, I feel that we may test this right shoulder pattern this year.  The validity of Technical patterns are driven by market participants and crowd psychology, and the fact that pretty much every institutional investor in the world as well as individual traders are watching this pattern is what makes it extremely powerful.

Check the 20 year S&P Chart above. The right shoulder is forming right now. The Head is the high we reached in 2007. Technical analysis experts will tell you that it’s critical that this right shoulder should pierce through the Head high at 1576 and go higher for this pattern to be negated or invalidated. If it does not do so, and the SPX turns back at some point, then the rules of this technical pattern dictates that the next low will be formed at about the “neck line” (This is the red line in the image). If we could extrapolate the red line into the future, this could mean a low of about 500 on the SPX. On the flip side, piercing through this high would provide a strong psychological boost, and we could see new highs for the markets in the years ahead. The only caveat in this pattern is to the downside. While the SPX needs to pierce through 1576 to confirm the upside, which is still 10% away, the pattern has already satisfied all the requirements to turn back and head downwards. It’s a beautiful, symmetrical pattern and is a legitimate right shoulder already. So it could turn back and head downwards anytime. Will the markets get a catalyst to make this downward move ? Could it be the debt ceiling negotiations in March and / or any more downgrades of the US ? Or could it be something else geo-political ? Of course, we don’t know. But 2013 shows all the signs of being a pivotal year for global markets.

Once again, Happy new year everyone !!

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