We Hit That Air Pocket – Now We Need the Capitulation Low. Line Up Your Longs.

September 30, 2013

We are going to hit that air pocket after all. The S&P 500 is down 15 points pre-open. We will be within striking distance of the 100-Day moving average and I will be watching for a capitulation low. The price action could get ugly the next few days.

As daunting as this decline might seem, maintain a buy the dip mentality. Once support is established, we will have an excellent buying opportunity.

There are a few speed bumps that the market has to deal with. First of all, the Senate passed a “clean bill” and they bounced it back to the House. This was expected. The House has one day to pass another version and send it back to the Senate. I don’t believe they will push for a one-year Obamacare delay, but they might repeal the medical device tax or they might force Congress and its staffers to go back on Obamacare. I believe there will be a few alternatives put back to the Senate to consider. It’s possible that the government will shut down for a few days.

The continuing resolution is not the major battlefield. The government should have enough money to last at least six weeks and it might have enough to get us into December. Republicans and Democrats will haggle, but the can will get kicked down the road. This leaves plenty of time for a rally.

Interest rates in Italy spiked this morning and their political climate is changing. I don’t believe this will become a major concern. Yields in Portugal, Spain and Greece remained low overnight. If this were a major credit event, you all of these rates would have moved higher. Germany’s Prime Minister (Merkel) was reelected last week by a large margin and she has supported EU bailouts. This little storm cloud will pass.

China’s official PMI came in a bit light and their market will be closed all week. This is just one data point and all of the other metrics for the last two months have been good. Economic conditions in Europe have also been improving.

Major domestic economic releases this week include ISM manufacturing, ISM services, ADP and the Unemployment Report. Growth has been steady and the four-week moving average for initial jobless claims is at its lowest level in five years. These releases might not rally the market, but they will lend support. Chicago PMI came in better than expected this morning.

Earnings season is just a week away and there have not been many warnings. This is a positive sign and corporations might provide encouraging guidance. They are lean and mean and any uptick in demand will go straight to the bottom line. Cash flows are at record levels and companies are using that money to buy back shares. Stocks typically rally into earnings season because the strongest companies announce early in the cycle.

Asset Managers want to get long into year-end. They won’t chase stocks at all-time highs, but they will buy dips.

The FOMC surprised the market when it delayed tapering. They probably saw this speed bump and they will remain accommodative until the debt ceiling is extended.

I’ve been hoping for a market pullback and I got one. Now we need to be patient and wait for a capitulation low. I want to see a deep intraday selloff and an instant rebound off of that low. In all likelihood we will briefly penetrate the 100-day moving average. If you want to see what this looks like, look at a chart of the SPY on 6/24 – that is when we want to get long.

Look for stocks that are in an uptrend and have broken through horizontal resistance. They will be drifting lower with the market and they will test that breakout. As the market continues to decline, these stocks will maintain that breakout. Once the market hits that capitulation low, these stocks will release and they will lead the charge.

I suggest buying November calls once that capitulation low is in. These calls span earnings season and implied volatilities will stay elevated. Your exposure to time decay is also lower if you go out to November.

Day traders can get short today. I believe the market will bounce mid-morning and you can fade that move once it stalls. We should see selling into the close. Do not hold short positions overnight.

I might take a few shorts today, but my primary focus is to find stocks that I want to buy.

Get ready for an excellent buying opportunity.
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