Evaluate Support at SPY $140. It Should Hold for Now. If That Level Is Breached – Buy Puts.

November 7, 2012

The last four years will seem bright by the time the next election rolls around. Obama won and we know that the Bush tax cuts will expire in 2013. Democrats should be able to postpone spending cuts even without the help of Republicans. Nationalized healthcare will kick in and that will impact corporate hiring. By 2016 the US will be more than $20 trillion in debt. Social Security and Medicare will not be restructured and structural debt will balloon as baby boomers retire.

This is not a prediction; this is the road we are on. The stock market does not like the news and the S&P 500 is down more than 20 points. I believe we will probe for support and SPY $140 will hold. Politicians will return to DC and traders will give them an opportunity to find a quick fix. The market will not be patient. If the rhetoric between both parties is heated, stocks will sell off immediately.

If the fiscal cliff provisions are implemented, many analysts believe that GDP could fall 5% in 2013. Capital gains taxes will increase and investors will lock in profits before the end of the year. This will create selling pressure and the market will drift lower.

You can’t get too aggressive with your shorts. Economic conditions are stable, stock valuations are attractive and balance sheets are strong. European credit concerns have temporarily subsided and China’s economic activity is improving. Politicians are skilled at kicking the can down the road and one statement about a quick fix to the fiscal cliff could spark a massive short covering rally.

The market is extremely news driven and my trade duration has been reduced. I used to be comfortable holding a position for 3 to 4 weeks and now I get nervous holding a position for more than 3 to 4 days. In the last few weeks, most of my activity is day trading. The market has no pace or follow-through and I don’t see that condition changing anytime soon.

Greece will vote on its austerity plan. If it does not pass, they will have to hold elections and they won’t get their next bailout payment. I believe the vote will be close, but it will pass. European credit concerns should remain subdued the rest of the year.

US economic releases are light and earnings season is winding down. All eyes will be on Washington DC. If they don’t attack the fiscal cliff problem right away, stocks will decline.

I am not going to trade today unless support at SPY $140 fails. If it does, I will buy a handful of puts. Today’s move is a knee-jerk reaction and I believe the selling is a bit premature. Traders are likely to evaluate the rhetoric first. If they don’t like what they hear in the next week or two, they will reduce risk.

If support at SPY $140 is tested and it holds for a few days, there is a tradable bounce. You’d better keep your size small and be VERY nimble. The next wave of selling will be the real deal if panic sets in.

My forecast is based on how politicians have acted in the past. They could not find a solution to the debt ceiling 18 months ago and they came up with the fiscal cliff. I do not believe they will find middle ground during a lame-duck session that is filled with holidays. If they do find a way to kick the can down the road, we will have a year-end rally. Unfortunately, this is an unlikely scenario.

Be patient and evaluate support at SPY $140.
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