Tuesday morning the S&P 500 extended its selloff, crashing through 2,080 support and the 50dma on its way to the mid-2,060s. But by late morning we exhausted the supply of sellers and closed 10-points off the intraday lows. Justifications for this week-old selloff come from two sources, oil pulling back from its highs and growing fear of a Brexit.
Last Tuesday evening I warned readers to be wary of a near-term pullback in oil and equities and that is exactly what happened. We don’t need be psychic to know what the market will do next, all we have to do follow the swings of sentiment and supply and demand. Last week traders were giddy as oil broke through $50, leading many to predict $60 oil wasn’t far away. Instead of surging higher, oil prices peaked and stumbled back into the $40s. So much for the wisdom of consensus. Stocks followed the same flight plan when it looked like we were headed to all-time highs, yet found ourselves stumbling under the 50dma instead. But that’s the way this works. One week’s giddiness gives way to the next week’s pessimism.
This week oil prices have been bumped off the front pages as the financial press fixates on next week’s Brexit vote. This was supposed to be a slam dunk for the “stay” vote, but the Brexit camp has surged in recent polls. That uncertainty is unnerving markets as traders start to fear the unknown. While this will be a hugely disruptive event if Britain votes to leave the EU, the economic consequences will be less bad than most fear. This is a referendum on refugee immigration, not trade. British citizens want to close their borders to Middle East refugees and given EU laws, the only way they can do that is by pulling out of the union. This isn’t a dispute over trade and no one wants to start a trade war since both sides are so dependent on the other. This means we should expect British and EU politicians to quickly sign into law comparable trade agreements to replace the previous EU ones. This will take place within weeks if not days because both sides want to minimize the economic disruptions. But politicians are not promoting “Plan B” because they are trying to use fear of economic calamity to persuade people to vote “stay”.
A Brexit vote would send the S&P 500 down a few percent because it is not currently priced in. But this will be a buyable dip for those who have the courage to be greedy when others are fearful. A week or two after the Brexit vote, many of the unknowns will have been ironed out and we will move forward with a plan. Norway and Switzerland survive quite successfully without EU membership and instead are part of a European Free Trade Association. Britain will do the same thing and life moves on. Since Britain never adopted the euro and still used the pound, there won’t be any of the financial entanglements that drove concern over a Grexit a couple of years ago. All the Brexit is doing is shifting from standardized EU trade agreements to ones made separately. Six one-way, half-a-dozen another. For all intents and purposes it will do the same thing no matter what the document is called.
As for how to trade this, Tuesday’s dip undercut popular technical stop-losses, purging a good bit of that supply from the market. The relentless slide under 2,070 also combined with the Brexit headlines to convinced emotional traders to get out “before things get worse”. Unfortunately for them reacting emotionally doesn’t pay very well. While the Brexit story isn’t done, we are closer to a buy-point than a prudent place to sell defensively. The best profit opportunities come from trading against an emotional crowd and the anxiety is ramping up as the VIX surges above 20 for the first time since February. Those with cash, get your shopping lists ready. Those with buy-and-hold stocks, don’t let the fear-mongering convince you to sell at a discount.
What’s a good trade worth to you? How about avoiding a loss?
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Jani Ziedins (pronounced Ya-nee) is a full-time investor and financial analyst that has successfully traded stocks and options for nearly three decades. He has an undergraduate engineering degree from the Colorado School of Mines and two graduate business degrees from the University of Colorado Denver. His prior professional experience includes engineering at Fortune 500 companies, small business consulting, 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 children.