Major Warning Shot. DC Has the Ball. Will They Fumble Or Punt? Stay Short

November 15, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Yesterday, the market broke key support at SPY $138.30. That was the 200-day moving average and once it failed, the selling pressure accelerated. Investors are scared and Asset Managers are taking risk off the table.

Politicians are known to drag their feet when faced with tough decisions. When it comes to entitlement reform, fiscal spending cuts and higher taxes they will postpone the pain as long as possible. Eventually, the market will tank and they will be forced to take action.

We’ve seen this in Europe and this movie is coming to a theater near you. Since President Obama was reelected a week ago, the market has dropped more than 5%. In his first press conference yesterday, I did not feel the love. He came across as being angry and the market started to decline. The stakes are high and both parties need to maintain a positive tone.

Many analysts believe that GDP in 2013 could fall 5% if we go over the cliff. Politicians will negotiate and all of the provisions will not kick in. However, we will see higher taxes and spending cuts. No matter what, that will reduce economic activity. We’ve been partying for the last decade and now we have to pay the bill.

If Republicans dig their heels in, Democrats could let us go over the cliff. Taxes will go up immediately and spending cuts can be postponed. Neither party wants this because middle-class Americans will get caught in the middle.

Corporations are flush with cash and they will sit this one out. In the last week, President Obama has approved 6,000 new business regulations. Companies are holding off on hiring decisions until they see how these new rules will impact them and they will evaluate the impact of Obamacare as it is phased in. This is not good for the job scene.

This morning, initial jobless claims were released. They spiked above 400,000 and that could be a sign of trouble. Empire Manufacturing also declined more than expected.

Europe released its GDP and although it was in line, they are officially in a recession. The ECB and the IMF are squabbling and Greece’s next bailout payment hangs in limbo. Over 1 million people rioted in Spain, Italy and Greece this week. Unions are on strike because of austerity cuts and the tension is building. European credit concerns remain subdued, but I am watching yields very closely.

China’s economic growth is stable and the new leadership has been announced. The selections were rather conservative and that means we will not see much reform in the next 10 years. Fiscal spending will increase and the PBOC will ease. They want to make sure this transition goes smoothly.

Israel assassinated a Hamas leader yesterday and they said this is just the beginning. Tensions in the Middle East are running high and the world is anxious to see how the US will respond.

Times are changing. In the last 80 years, we’ve only seen one market decline the week after an incumbent is reelected. Stocks typically rally into year-end and Asset Managers worry that they will miss the move. When seasonal/historical trends like this fail, it is a major warning sign.

I’ve been telling you to get short this week and I hope you took my advice. I still believe we will probe for support. Until there is concrete evidence that politicians will strike a deal, the market will drift lower. We will see an occasional bounce on lip service from Washington. However, those moves will fade quickly and Asset Managers looking to reduce risk will sell into strength.

Congress only has 14 working days between now and the end of the year to get this done. In a lame-duck session, I am not very optimistic. Both parties had 18 months to find a solution and they did not. Investors, corporations and ratings agencies don’t have any confidence in our government.

If DC does pull a rabbit out of its hat, the market will find support and we will have a small rally into year end. That enthusiasm will fade quickly as investors evaluate the impact of spending cuts and tax increases in 2013.

The market will try to move higher this morning and bargain hunters will give up when they can’t get any traction. The horrible initial claims number almost guarantees that the downside will be tested. We will see selling late in the day. I expect to see the market decline into the weekend.

I am long puts and I have a full boat. I will protect profits and I will start scaling out of some of my positions if we get another wave of selling. I don’t like to hold big positions into a holiday and Thanksgiving is a week away.

In this volatile market, don’t be afraid to take profits. We will hear many promises from Washington. Those “sweet nothings” will spark rallies and you will have opportunities to get short.
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