Earnings Season Starts Tues – Debt Ceiling Rhetoric Will Determine If We Breakout.

January 7, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

In the last two weeks, we’ve had a 5% decline and a 5% snapback rally. There is no pace to the price action and the market feels a bit heavy. We are close to multi-year highs and this resistance level should hold.

Asset Managers will not chase ahead of earnings season and the debt ceiling negotiations. Alcoa will kick off earnings season tomorrow and it could cite growth in China. That would be bullish for the market. Major releases won’t begin for another week. Revenues are likely to be flat and that will not excite investors.

Democrats are warning that Republicans had better not use the debt ceiling as a bargaining chip. The GOP will lose some of its voice this week as Democrats replace Republicans in the House and Senate. President Obama will bash the GOP during his inauguration speech and that will also reduce their power. The Republican Party is already weakened. Moderates and the Tea Party are divided and Republicans argued with each other last week when hurricane Sandy relief was delayed. This could mean that Republicans will cave-in during the debt ceiling negotiations.

The U.S. Treasury can avoid default for another seven weeks. Obama will push for higher taxes. He wants to place limits on deductions and he wants to remove loopholes. Republicans want to reduce spending, but most of the proposed cuts are defense-related they don’t like that. The GOP also wants entitlement reform. At best, I believe taxes will remain the same and the spending cuts will come from defense. The eligibility age for Medicare will increase by two years and Republicans will extend the debt ceiling for two years.

The market would rejoice if this scenario plays out. This would be like punting “the can” 50 yards. Democrats would have a blank check and they plan to retake the House and the Senate in 2 years.

Investors discounted the fiscal cliff and it feels like they will discount the debt ceiling. Investors won’t worry about it unless the negotiations come down to the wire and the rhetoric is ugly.

Our credit rating might suffer as a result, but that decline will be temporary. Central banks around the world are printing money like mad and developed nations are running massive deficits. All that matters is that we maintain our credit rating on a relative basis.

Option implied volatilities (VIX) plunged to multi-year lows last week. That tells me that fear is extremely low and Asset Managers believe that the can get kicked down the road.

Deficit spending will explode and our national debt will eclipse $20 trillion in the next few years.

Bond yields are at historic lows and stocks are attractively valued. Even if revenues are flat, balance sheets are extremely strong. Any economic uptick will produce nice profits since companies are running lean and mean. Money has to flow somewhere. It’s not earning anything in the debt market and inflation makes cash a losing proposition.

Long-term, we all know that this will come crashing down. However, this is not the time to worry about it. There will be plenty of warning signs and as long as interest rates remain low, the market will move higher.

If it sounds like I am turning bullish, I am. I did not like the way the fiscal cliff played out. Republicans are playing a weak hand and their strategy has been flawed.

Two weeks ago I outlined two scenarios – “pain now” or “pain later”. It looks like we will postpone pain as long as possible.

Resistance at multi-year highs will hold for now. We are likely to see a little soft patch into earnings season. We will find support above the 100-day moving average.

The rhetoric during the debt ceiling negotiations will determine if we are able to break out. If Republicans look like they will cave-in, the market might discount the threat of a default. Decent earnings could push us through.

If the rhetoric is ugly, stocks will retreat slightly and they will be poised for a massive rally once the debt ceiling extended.

The market feels a little heavy right now, but it wants to move higher.

I’m still using my day trading strategy. If the market is above its one-hour high, I am trading from the long side. If the market is trading below its one-hour low, I am shorting stocks.

The calendar is pretty light this week and the daily range could be tight ahead of earnings season. As the announcements increase, the volume will return.

Keep your size small and know that you’re only a week away from a better trading environment.
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