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The nice two-day rally ended yesterday when comments between Boehner and Obama soured. A fiscal cliff deal is priced into the market and investors are getting nervous. Stocks are within striking distance of the 52-week high, but I don’t believe we will breakout without a debt ceiling extension.
Yesterday, the Speaker of the House proposed “Plan B”. It terminates the Bush tax credits for Americans making more than $1 million per year. The rest of the fiscal cliff provisions would remain. The President said he would veto this bill immediately.
Spending cuts and entitlement reform are the big issues and they can’t be addressed in a handful of days. Revenues (tax hikes) are the only topic of conversation. Republicans know that the debt ceiling is their only bargaining chip and they will not part with it.
I believe Democrats will counter with the termination of Bush tax credits for Americans making more than $400,000 per year if the debt ceiling is extended one year. Republicans will not “bite”. They will probably counter with an extension of the Bush tax credits for Americans making less than $250,000 per year, but there will not be a debt ceiling extension.
This what Obama has been asking for and I believe Democrats will agree to it. This will still keep taxes low for 98% of Americans and Democrats don’t want to alienate a huge voter base ahead of the new year.
This agreement might spark a small rally, but it will be short-lived and I doubt the highs of the year will be challenged. Asset Managers will reduce risk ahead of debt ceiling negotiations in February. The last time we went through this process the US lost it credit rating. Yesterday, Fitch said that it is not impress the progress so far.
If Republicans agree to extend the debt ceiling, the market will rally to new highs. Democrats will have a blank check and there won’t be any pressure to cut spending or reform entitlement.
The economic news has been decent. GDP, the Philly Fed and initial claims came in better than expected. China’s releases (retail sales, industrial production, exports, flash PMI) came in better than expected last week. Europe is in recession but its flash PMI was better than feared. The EU agreed to a centralized banking authority and Greece secured its next bailout payment.
Earnings releases this week have been mixed. Oracle and FedEx were better-than-expected and Bed Bath & Beyond and Accenture disappointed.
Macro conditions are fairly positive and the market wants to rally into year-end. The price action hangs on every word out of Washington DC and I am keeping my overnight exposure to a minimum. The market has not been making big gaps and there is no reward for long-term positions.
I have been using this strategy with excellent success. Note the one hour trading range for the SPY. If we are trading above it, buy stocks. If are trading below the one hour range, short stocks. The market opened flat on Monday and Tuesday and you would’ve caught entire rally both days without any overnight risk. Yesterday, the market opened flat and you would’ve gotten short after the first hour. This strategy caught the sell-off and you would have made nice money in the afternoon.
I’ve been writing about this strategy for more than a week and the stocks at the top of the Live Update table have performed extremely well. I will stick with what is working.
My gut tells me that the price action will be soft and politicians will strike a mini deal. Stocks will rally and the momentum will stall because the debt ceiling won’t be extended.
This is not something I can predict. Republicans could cave in and extend the debt ceiling. Consequently, I will stick to day trading and I’ll keep my overnight risk to a minimum.