Air Pocket – Obama Says Market Should Be Worried – SPY 100-Day MA Will Be Tested

October 3, 2013

The market wants to head higher, but the debt ceiling stands in the way. Traders are scrutinizing every word out of DC and stocks are chopping back and forth.

This scenario reminds me of December 2012. Debt ceiling negotiations were getting ugly and Asset Managers completely discounted the probability of a default. Stocks rallied on the notion that a deal would be reached.

As the December 31st deadline approached, politicians continued to drag their feet. The market dropped 5% in the course of a week. DC extended the debt ceiling, but it is not like they reached an agreement. The sequester happened even though both sides were trying to avoid it. Stocks snapped back once the threat of default passed.

Asset Managers have a longer investment horizon than I do. They also have deeper pockets. They will buy dips at this level on the notion that any decline will be brief. That does not mean that it will be shallow.

It might seem logical to scale into call positions at this time. If politicians pull a rabbit out of their hat, you will have a long position. If the market tanks, you can add to your longs at a better price. If we were not dealing with ideologues, this approach could work for some traders.

I do not fall into that class. The drop last December was very daunting and our country faced a potential credit downgrade. When prices are plunging you lose your appetite to average your cost down. It takes a tremendous amount of fortitude and conviction to whether this game of “chicken”. As you can tell, I have very little faith in our leaders.

Both parties are polarized and yesterday President Obama said that the market should be worried. He also said that this time is different.

Politicians have leapfrogged the CR and they are focusing on the debt ceiling. The market will decline on nasty rhetoric and it will rebound on closed-door meetings that hold promise. This will drag on until the deadline. Eventually, the market will tank and it will force politicians to find middle ground.

The good news is that a year-end rally lies ahead. Global economic conditions continue to improve. Earnings season starts next week and there have not been many warnings. Profit margins are healthy and any uptick in demand will go straight to the bottom line. The Fed saw this storm cloud and they remain accommodative. These are all bullish events.

From a swing trading standpoint, I don’t see any reason to trade. Stocks could rally on any sliver of good news, but the debt ceiling will keep a lid on the market. The chance of hitting an air pocket is high – so avoid the risk. I would only consider buying calls on a deep decline below the 100-day moving average. Even then, I would need to hear constructive rhetoric out of DC. If option implied volatilities spike (they are currently low), I would also consider selling out of the money puts on strong stocks.

Once the debt ceiling is extended, I would aggressively buy calls. That might mean buying into a massive relief rally, but I am prepared to do it. This is the only remaining dark cloud. Tapering will not be a big deal if the Fed starts gradually during a period of economic expansion.

From a day trading perspective, I will buy dips on an intraday basis once support is established. This will work ahead of the deadline. Asset Managers will remain optimistic and they will nibble.

Today the market senses that this negotiation process will take a while and it is drifting lower. It is very dangerous the short these declines because one encouraging comment could spark a reversal. Day traders should try to buy deep intraday dips once support is established and swing traders should stay on the sidelines until a deal is reached.
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