For a few weeks now I have been warning you about the fragile state of this rally. The easy money has been made and you should have trimmed your size. Asset Managers won’t chase stocks at an all-time high and some will be tempted to take profits. If the market drops to a support level, buyers will nibble.
Bullish speculators got flushed out yesterday and we should see the final wave of selling today. Once the momentum was established Wednesday, Asset Managers pulled bids and we hit an air pocket. We’ve seen these reversals off of all-time highs a few times in recent weeks. The market has been able to stabilize quickly and I am expecting the same this time around.
I’m happy to be sidelined and I see a nice buying opportunity setting up. Fortunately, the market provided us with some action. Without this move, we could have fallen into a very tight and dull trading pattern the rest of the year.
The market will probe for support this morning and it should find it at SPY $178.00. If that level holds, stocks will rebound the rest of the day. If that level fails and we continue to drift lower, $177.50 could be tested. The next support level below that is $175. If the market continues to drift lower today, I will stay sidelined.
If the market is able to find support and rally above SPY $179 by mid-morning I will buy calls. If it continues to grind higher I will complete the position (20% of my normal size). This is not a time to swing for the fence. My stop for the position will be a close below $178.50.
If the market does rally, I will focus on stocks that held up well yesterday. In particular, I will be looking for stocks that have recently broken through horizontal resistance (or are about to). I will buy in the money calls that have a high delta. I don’t want to expose myself to time decay and these options tend to be liquid. I am also looking for stocks that have very tight, predictable price patterns.
The news has been good this week. A budget deal is a big positive. CNBC’s Chief Economist believes that the Fed will taper next week. He is a credible source and I hope they do. Even a $1 billion reduction in bond purchases would get this monkey off of our back. The Fed would also send an economic vote of confidence and it could be a “buy the news event”.
Tapering does not mean tightening. Rate hikes are still years away and Janet Yellen is dovish.
The budget deal might be signaling a new climate in DC. Democrats have been humbled by the failed rollout of Obamacare and they are willing to negotiate. The GOP does not want to provide them with any ammo and another government shutdown would do that. Consequently, Republicans are also willing to negotiate.
Republicans could agree to extend the debt ceiling in Q1 and that would be bullish. They sense that Obamacare will implode. As usual, I need to remind you that I am not making a political statement. I am simply trying to interpret their actions so that I can predict future decisions. The government has a huge impact on market direction (unfortunately).
I do believe that Obamacare will be a dark cloud in 2014. Those without insurance (low income Americans) will benefit. Unfortunately, they do not contribute much to economic growth. The rest of America will have to finance the cost and it will come in the form of higher premiums and higher deductibles. This is equal to a big tax and it will reduce consumption. Healthcare accounts for 18% of our GDP and this will impact every family.
The government has been slow to rollout the program and the costs have been closely guarded. We won’t know the full impact until the end of the first quarter so this dark cloud is still off in the distance.
In summary, the storm clouds are off in the distance and the market will be able to find support. Watch for an early low this morning and keep an eye on the support levels I outlined. If we bounce, stocks will gradually recover. I am not looking for a massive rally, but a move from SPY $178 to $182 would provide nice profits. Keep your size small.
Do not short this market. Wait for support and buy calls on stocks that are breaking through horizontal resistance.