Stocks slipped at the open as a Debt Ceiling deal remains elusive. We are within days of default, but the market remains relatively calm and is less than 2% from all-time highs. We recovered the 50dma last week and are holding near 1700 in anticipation of the inevitable Debt Ceiling/Gov’t Shutdown compromise out of DC.
Stocks recovered from last-week’s lows of fiscal doom-and-gloom as the fear of default transitioned to expectations of a last-minute deal. While the market seems bipolar when it changes its opinion so quickly, we must remember it is not a single entity, but a collection of individual opinions. The appearance of contradictions arises due to a churn in ownership as those that feared default sold at a discount to investors looking past current headlines. As we ran out of fearful owners rushing for the exits, supply dried up and we bounced on the confidence of new owners expecting a resolution. Markets are not about what will happen, but what people think will happen.
While we still don’t have a deal, stocks are holding up as most expect one over coming days. While this leads to near-term support and stability, it also mitigates the size of upside following a deal. Since most of the rebound occurred in anticipation of a deal, there isn’t much left to follow the news. This will likely turn into a buy the rumor, sell the news trade, so there is little reason to chase a breakout. That doesn’t mean the market will rollover, just that the grind higher will resume and traders will have plenty of time to get in on their terms.
Since most expect a resolution, that leaves lots of downside if we fail to reach a deal. A default will send a stampede of sellers rushing for the exits at the same time. This is the Black Swan trade, a low probability outcome with catastrophic consequences. A prudent trader will protect long positions with cheap insurance and an opportunist could place a low-cost bearish bet that will pay off handsomely if the low-probability event becomes a reality.
The high probability trade is owning this market, but watch the Black Swan closely and recognize a default could send us down 15% in a matter of days. While we could buy the dip last week, as second dip on default is one to be avoided and even shorted.
Plan your trade; trade your plan
Jani Ziedins (pronounced Ya-nee) is a full-time investor and writer who has successfully traded stocks and options for more than a decade. He earned a B.S. in Mechanical Engineering from the Colorado School of Mines and an MBA and M.S. Marketing from the University of Colorado Denver. His prior professional experience includes manufacturing engineering at Fortune 500 companies, structural engineering, small business consultant, collegiate instructor, and managing investment real estate. He is now fortunate enough to trade full-time from home, affording him the luxury of spending extra time with his wife and two young children.