The Bounce Has Stalled – Buy Puts. QQQ Breaking Below 200-Day MA

December 4, 2012

Yesterday, stocks tried to rally on beginning-of-the-month fund buying. The market bumped up against resistance and the momentum stalled. After a volatile month of trading, we are right back where we started in October.

Global economic conditions have been stable, but soft. Europe is officially in a recession and China’s growth has slowed to its lowest level in years.

Japan faces a fiscal cliff of its own. More than 25% of its annual tax receipts go towards interest on its national debt. It has the highest debt to GDP ratio (220%) of any G7 nation. A territorial dispute with China has impacted trade between the two countries. I still believe this could be the source of the next financial crisis.

Domestically, we are treading water. Major economic releases will be posted this week. Sandy will weigh on activity and employment. I believe the market will give these numbers a “free pass” because the hurricane affects are temporary. There is a strong economic undertow and I believe it will be masked by the storm.

Corporations don’t like uncertainty. New business regulations, Obamacare and the fiscal cliff will impact profits. Companies will not invest or add to headcounts until they have clarity.

Demand is an even bigger issue. The global scene has deteriorated and domestic conditions are fragile. Debt levels in the US are at all-time highs (federal, state, municipal and personal). Spending has been reduced across the board.

Central banks have artificially prolonged this economic cycle. Interest rates are zero (US, Europe and Japan) and central banks are out of bullets. Recent quantitative easing has not stimulated economic activity and we will finally have to go through this cycle. Because it has been artificially sustained, the contraction is likely to be prolonged.

Politicians usually drag their feet until they are forced to take action. The market believes that lawmakers will get anxious during the holiday season and they will come to an agreement. This scenario is already priced in and I am not so optimistic.

The stakes are higher than they’ve ever been. Both parties are polarized and this is a power struggle. Republicans and Democrats have submitted their proposals and they are miles apart.

If a watered-down solution is reached, the market will rally. That move will soon exhaust itself. We will bump up against the debt ceiling in another month or two and we will have to go through that ordeal.

The President is trying to gain power so that he has unlimited spending authority. He does not want to lose face during another debt ceiling debacle. The Senate is trying to change rules to eliminate filibustering. This would also diminish the voice of Republicans. These checks and balances where put into place for a reason and these actions by the Democrats are antagonistic.

It is almost impossible to predict how the market will react to the ongoing saga in DC. The market has priced in a best case scenario and I believe the any surprise favors the downside.

Taxes must increase, spending must be reduced and entitlement needs to be reformed. No matter how you slice it, pain lies ahead. Investors know this and I believe they will reduce risk (sell stocks) into year end. That selling will offset end-of-year buying.

I am looking for a swift decline and a snap-back into year-end.

The upward momentum has stalled and we should see selling pressure. I am not trading the upside; I am simply waiting for a breakdown below the 100-day moving average. When that happens I will buy puts and if the SPY breaks below the 200-day moving average, I will add.

Watch for a drift lower today.
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