The market surged to new highs after the FOMC decided not to taper. It got a little ahead of itself and bullish speculators were flushed out this week. Political wrangling over the continuing resolution (CR) has sparked a little profit taking and that should run its course this week. The bid will strengthen with each passing day.
The House passed a bill to extend the continuing resolution if Obamacare was defunded. The Senate will reject it and return a “clean bill” back to the House this weekend. Time is running out and the House is likely to add some type of cut into the bill (Obamacare for Congress and its staff). This would be popular with all voters and I don’t believe the Senate will be able to reject it. The market will breathe easy for a few weeks and stocks will rally.
The news has generally been good. Flash PMI’s were better than expected, the FOMC is very accommodative and Janet Yellen is likely to become the next Fed Chairman. Major economic releases next week (ISM manufacturing, ISM services, official PMI’s, ADP and the Unemployment Report) will be market friendly and they will take some of the focus off of the debt ceiling.
Seasonal weakness is winding down and we should see some end of the month fund buying next week. This is also the end of the third quarter and there will be “window dressing”. Earnings season will start in two weeks and there have not been many warnings. Stocks typically rally into the announcements and this is another bullish influence.
Corporate profit margins are healthy due to cost-cutting and any uptick in demand will go straight to the bottom line. Cash flows are at record levels and companies are using the proceeds to buy back shares.
The debt ceiling will loom, but the market will discount it since the can always gets kicked down the road at the last minute. Obamacare is extremely complex and Democrats would be wise to delay the rollout by a year. If they do this the GOP will extend the debt ceiling. This is a possible scenario and the market is pricing it in. The rhetoric will get ugly during the negotiation process.
I am buying November calls if the SPY closes above $170. I will add if the SPY closes above $171. I want to go out to November because those options span earnings releases. Option implied volatilities will hold their value and my exposure to time decay will be reduced relative to October call options.
In particular, I am looking for stocks that are in a strong uptrend and have broken through horizontal resistance. That breakout needed to hold during the recent market pullback. Now that prices are starting to firm up, these stocks will push higher.
The rally this morning feels like it will hold and stocks should continue to rebound next week. We could see a little speed bump with the CR this weekend, but that should be resolved quickly.
Be prudent and scale into November call positions using the guidelines above.