Are markets complacent?

MARKET BEHAVIOR
More weakness as emotions run high ahead of the looming Debt Ceiling.

MARKET SENTIMENT
The best way to classify market participants isn’t fundamental/technical/momentum/value, but timeframe.  Traders and investors have holding periods ranging from fractions of a second to decades and that says a lot about how they trade and their effect on near-term supply and demand.  Why this matters is it gives us clues to who might buy or sell at any given time.

Several big money managers came out publicly and said they have no intention of selling the debt ceiling weakness.  Bears point to statements like that, claiming it is proof of complacency.  No, that is simply the product of a longer time horizon.  Anyone who is looking ahead six or twelve months is not paying much attention to a two-week political standoff.  The only reason they follow near-term weakness is looking for opportunities to buy discounted shares, and that is exactly what these managers said they plan on doing.

Most daily price moves are driven by shorter-viewed traders trying to anticipate headlines and market moves.  We will start with the extremely active High Frequency Traders.  This is a billion dollar sliver of a trillion-dollar market, yet this small pool of money accounts for more than 50% of the daily trading volume.  We can say similar things about day and swing traders.  They are a very small group as measured by combined portfolio size, but because they trade hundreds of times a year, they carry far more influence in daily market moves than institutional money that holds positions for a year or longer.

Right now short-term money is selling by the fistful ahead of the widely expected crash.  While these active traders have a lot of influence over daily price moves, their limited size means they don’t have the firepower to extend moves.  When shorter viewed investors sell the headlines, but longer-viewed investors continue holding, that means the downside move will stall as soon as the short-term traders run out of money.  In June selling stalled and ended that selloff.  The same thing happened again in August.  While there are no guarantees in the market and selling often shakes the conviction of previously confident bulls, longer-term investors unwillingness to sell near-term headlines is supportive and bullish because it keeps supply out of the market.

TRADING OPPORTUNITIES
Expected Outcome:
While it is hard to be confident in environments like this, current worries are as artificial as the politicians causing them.  Assuming our political leaders don’t take us off the cliff, these issues will be behind us in a matter of weeks and this weakness is a buying opportunity.  While that is a big assumption, the only way to make money in markets comes from taking risks; traditionally the bigger the perceived risk, the bigger the ensuing reward.

While the rhetoric is as divisive as ever, a likely resolution is coming to light that lets both sides save face and kick the can down the road.  Obama wants a “clean” bill and the GOP wants face-to-face negotiations.  That means we will likely get a small lifting of the debt ceiling and budget extension, leading to more structured deficit and tax negotiations between the parties over the next month.  While a similar resolution lead to the arbitrary Fiscal Cliff and Sequester, that is still preferable to continued gridlock and default.  By most measures the market and economy swallowed the Sequester without problem, so a sequel is not necessarily a bad thing.

Expect the volatility to persist and a minor relief rally on a temporary extension of the budget and debt ceiling.

Alternate Outcome:
As long we continue marching toward default, there is a real risk we will crash and burn.  While political gridlock is SOP, failing to pay our bills will have very real consequences for our economy and ability to sell debt in the future.  Short-term treasuries are the oil that keeps money moving in our economy.  Perception of liquidity and zero-risk is what makes Treasury Bills an attractive vehicle for banks and major employers to hold liquid funds.  Cut that off for even a couple of days and people can no longer get loans or make payroll, sending the economy into temporary chaos.  This has never happened before and no one knows how it will end, meaning the market will sell first and ask questions later.

Trading Plan:
Tuesday’s selloff triggered stop-losses under recent lows and flushed out many of the hopeful, leaving us with a larger percentage of owners less concerned about the near-term political noise.  This is potentially supportive of current levels.  There is no reason to catch a falling knife, but if we hold these levels for a couple more days, it suggest the emotional selling ended and most owners are willing to continue holding this uncertainty.

If we avoid default, most of the selloff has been realized and this is a decent place for a bear to take profits.  The best way to trade a default is using cheap options as a lottery ticket in the unlikely case our politicians take us off the cliff.

And of course there is no reason to be in the market here.  Hopefully many bulls locked in gains at higher levels and are looking for a good entries to take advantage of these discounted shares.  Savvy bulls embrace pullbacks because they let them make even more money.

INDIVIDUAL STOCKS
AAPL remains in between $500 and the 50dma, but it is resting just above this rapidly rising moving average.  While it doesn’t have the same influence as levels where large numbers of traders bought or sold shares, it is widely followed and often used in forming trading opinions and outlooks.  Rumor is the iPad refresh will happen later in the month with the 10″ iPad adopting the Mini’s slim design and the Mini getting a Retina display.  These are nice incremental gains, but because iPads are not subsidized, we see a much slower upgrade cycle as compared to the iPhone.  Buyers will appreciate these enhancements, but expect most iPad owners to stick with their current model.

The broad market uncertainty is taking the air out of TSLA as it finally tests the 50dma for the first time in several months.  While not a fundamental flaw in the story, we have to be careful with any stock that has come as far as quickly as TSLA has.  TSLA’s bubble will likely burst on a fundamental catalyst, meaning recent weakness is likely a buying opportunity, but you need an iron gut to hold this one when it is down 10%+ over a few days.

Plan your trade; trade your plan