Nasty Market Decline Ahead – Be the Second Mouse

March 2, 2018
Author: Peter Stolcers, Founder of OneOption

Posted 9:30 AM ET - Yesterday the market broke horizontal support at SPY $270. Stocks continued to drift lower and news of steel tariffs spark selling. The 100-day moving average was tested and it held. This morning we are seeing another wave of selling and we are going to blow through that support level. A number of factors are casting a dark cloud over the market and this is a great time to be on the sidelines. In his testimony before Congress this week Fed Chairman Powell said that there could be four rate hikes this year. That is hawkish and it makes a rate hike in March very likely. In the early stages of rising rates the market is usually soft. Investors need to see proof of growing economic activity and moderate inflation before they start buying. I believe we are at that juncture right now. Economic growth hit a soft patch and China's PMI was weak. US durable goods orders were also down. ISM manufacturing was pretty strong yesterday. We need to see strong growth and a 5.3% print on Q1 GDP would do it. I'm expecting excellent job growth next week (ADP and Unemployment Report). Inflation is another concern – specifically wage inflation. This is the largest input cost for corporations and they have to raise prices to maintain margins. The good news is that workers make more money and that fuels economic growth. I believe the spike in wages is due to the tax cut. Corporations willingly shared the benefit and I believe this spike will end in the next month or two. CPI, PPI and PCE have been benign and inflation is moderate in those areas. Oil prices have been dropping and that will keep raw material/transportation costs down for producers. Fear of a trade war with China is brewing. Trump announced tariffs on steel. This is not the first time we've imposed tariffs, but news outlets certainly make it feel like that's the case. In my opinion Trump is sending a message to China that trade negotiations need to take place. We are not going to put up with "dumping" and patent theft. If China removes tariffs on US goods a trade war can be avoided. There is a second component to the tariffs. China has been conducting trade with North Korea and they have not enforced sanctions. Now that the Olympics are over "rocket man" will resume missile tests. Again, Trump is trying to use some leverage. I don't know how all of this will play out, but the market is reacting negatively to this uncertainty. Corporate earnings are strong and guidance is fantastic. Valuations are at the upper end of the range and we have room to retrace. Now let's talk trading. The temptation is to dive into big moves is great. Someone is making money - right? In my opinion this is a great time to be sidelined. I live by an old market adage: "The second mouse gets the cheese". The market is going to plunge through the 100-day moving average, but that move has already been made before the open. Option implied volatilities will spike and bid/ask spreads will be a mile wide. It is almost impossible to make money buying options in this environment. Selling options requires a great deal of skill and you need to watch for capitulations during the day. My tone has turned neutral during this second wave of selling. This bottoming process needs time. Asset Managers are reducing risk. Tariffs and wage inflation might be confirmed next week. Investors will not stick their necks out this now. A Fed rate hike at the end of the month is also possible. With all of this negative news some traders will get short. All it will take is one dovish statement from the Fed Chairman to spark a violent snapback rally… or perhaps Trump could postpone the tariffs. Swing traders I urge you to stay sidelined. We've had a fantastic year and we are sitting in cash waiting for the dust to settle. I don't know how long that will take, but I do know that it will present an excellent opportunity. Option buyers need to wait for the technicals to set up and for option implied volatilities to settle down. This could take weeks. Day traders should use the 100-day moving average as a guide. If the market is above the 100 day moving average favor the long side. If the market is below the 100-day moving average favor the short side. I suggest trading stocks and futures. Avoid options. The bid/ask spread is too wide and IVs are high. I also suggest trimming your size. The moves are much bigger and trading smaller size gives you staying power. I feel that the 100-day moving average will fail and it will become resistance. There are too many unresolved issues in the next few weeks and Asset Managers are not buying unless we hit an air pocket. In the next couple of weeks we could test the 200-day moving average again. . . image

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