Stocks opened weak as the political debate rages on, but resulting trade stayed in a tight range above 1700.
If we believe the headlines, we are on the verge of getting a deal out of the Senate, but how the House reacts is anyone’s guess. No doubt there will be many Tea Partiers that will vote against anything, so it is really a matter of Boehner putting a compromise up for a vote and then splitting the GOP between moderates and fundamentalists. From there we have to reconcile the Senate and House bills.
The Oct 17 deadline is really just an invented date and passing it doesn’t automatically trigger a default. At this point it seems likely this debate will carry past the deadline since it will take time to merge the two chamber’s bills, but we can probably stretch through the weekend without roiling the markets. We might get another credit downgrade, but Wall Street saw how trivial the economic impact was following the 2011 S&P downgrade, so it shouldn’t lead to a large selloff here. Further, the ratings agencies saw how S&P lost credibility when they downgraded US debt and it continued to increase in value.
So far the daily trading pattern has been opening weak as traders are disappointed with debate dragging on and bears hoping to jump on a market selloff, but then recovering losses by midday as the selling fails to gain momentum and we run out of sellers. Headlines don’t matter when anyone afraid of them is already out of the market. We saw this train coming from a mile away and anyone expecting a Default bailed out weeks ago. Those still hanging on show a willingness to own in the face of these headlines and are not rushing to sell every bump in the road. Success in the market is not anticipating headlines, but understanding how traders will react to these headlines. No matter how bad it sounds, if there is no one left to sell, markets hold up due to tight supply.
The market largely expects a resolution and much of those gains have already been priced in. We could see a dip back to the 50dma if be wake up Oct 18th without a deal or we could see a sell the news after a deal is reached. But that is what markets do, they go up and then they go down. We’ve had four up days pull us off recent lows and red days are inevitable. I don’t expect a large selloff following a deal letdown since this entire event was invented in Washington and has no real structural impact for the economy or the markets. This was a speedbump and soon we will back to normal.
While most expect us to avoid default, the market is afraid of the consequences if we plunge off the cliff. While we have cooler heads hammering out a compromise, no doubt there will be a lot of resistance from the rank and file when the bills are put up for a vote. Expect this to drag on past the Oct 17th deadline. If previously confident traders see this as a hard-line and wake up Friday morning, selling everything they have at the open, we could see a cascade of selling take us lower. While unlikely, we need to be wary of a spooked market.
Anyone waiting to buy the resolution will be too late. And not only that, many expect the market to pop on a resolution, meaning it is largely priced in. At this point it is a bit late to chase the rebounds strength and it is better to wait for the impending pullback, either as the debate drags on, or we sell the news following a resolution. Many shorts are hoping for a default plunge and their covering will provide a one day short squeeze, but expect buying to dry up since most bulls already own the market. No matter what, a bullish market should hold the 50dma and violating this means we need to reevaluate our bullish outlook.
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.