Market Hit the Air Pocket – Now We Need A Capitulation Low. Potential Trade Ahead of FOMC Minutes

October 9, 2013

Yesterday the market hit the “air pocket” we have been looking for and the SPY closed below the 100-day moving average. I told you that a new low after a couple hours of trading would be bearish. Bullish speculators are nervous and another wave of selling will flush them out of positions. We are a week away from the debt ceiling and the tone in DC will remain antagonistic.

Janet Yellen will become our next Fed Chairman. That was priced into the market and the early rally quickly faded. The market will probe for support.

This afternoon the Fed minutes will be released. If the taper was postponed because of the debt ceiling, the market will have a negative reaction. This would signify that tapering will begin as soon as the debt limit is raised. On the other hand, if the Fed plans to wait until 2014, that would be bullish. This seems more likely since the FOMC might want the new Chairman to initiate this action.

If the market has a nice dip today, buy ahead of the FOMC minutes. Once the news is out, maintain a tight stop. If we have a nice bounce, take profits near the close. If the SPY closes above $166, hang on a small part of the position overnight. This is still a day trading environment.

The earnings overnight were mixed. Alcoa was good and Yum and Costco were not. Pre-earnings warnings are mounting and 90 of the S&P 500 companies have lowered guidance. Banks will start posting results on Friday and estimates have been lowered. Trading volumes are down, legal expenses are up and mortgage refi’s have declined.

The best case scenario would be a one-year debt ceiling extension with some concessions by Democrats (Keystone pipeline, tax holiday for repatriation, repeal of the medical device tax or minor entitlement reform). Both parties can save face and the economy can continue its fragile recovery. This outcome would result in a massive year-end rally.

The worst-case scenario would be a temporary extension. This will give politicians more time to argue and business investment/hiring will decline amidst uncertainty. We saw this play out in 2011. The market will stage a small relief rally back to the highs of the year and it will stall.

This nasty battle would normally put our credit rating at risk, but it won’t be lowered by domestic agencies for one reason. Standard & Poor’s took a tremendous amount of heat from the government when they did so in 2011. Borrowing costs escalated and politicians were angry.

DC has been on a witch hunt and they are reviewing the role of credit agencies. Standard & Poor’s wants the wounds from the financial crisis of 2009 to heal. If it pushes the envelope it could be subjected to new regulations. You won’t hear anyone talking about this, but this potential threat will impact their decision-making.

We still need to see a capitulation low. Stocks need to stage a huge intraday decline and they need to quickly recover from those lows. Once we see that price action, we can start buying November calls. The debt ceiling might not be extended at that point and we don’t want to fire all of our bullets. It will simply be a sign that Asset Managers are eager to buy at that level.

Once we have visited those depths, politicians will forge an agreement. We will also hear rumors before a deal is signed and any closed door meeting will spark a mini rally.

This is a good entry level, but we have to be patient. Wait for that capitulation low before you buy Nov calls.

Day traders take a long position before the FOMC minutes and follow the instructions above.
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