The levelheaded way to approach Wednesday’s selloff

Free After-Hours Analysis: 

The Republican’s widely anticipated “red wave” turned out to be little more than a “red ripple”.

As is often the case, the market’s reflex is to buy Republican victories and sell Democrat wins. And Wednesday was no different with the index tumbling 2% following the latest Republican letdown.

While this politically skewed view of the stock market is easily debunked by looking at historical performance under different administrations, that doesn’t stop partisan investors from sour grapes selling in the hours and days after an election.

Now, I will be honest, I had no issue with stocks slipping in a knee-jerk reflex to the Republican fumble, but I thought the market would find its footing and move past the election by Wednesday afternoon. A split government is a split government and Republicans don’t need large majorities or even both houses to stifle the Democrat’s legislative agenda. But obviously, the market saw it differently and the selling continued through the afternoon.

There are two possible explanations for this:

If the market’s latest rebound from the October lows was built on expectations of a “red wave”, that means there is a lot of air underneath us since this “red wave” failed to materialize. Partisans buying the rumor and then the rumor turning out to be wrong is a recipe for falling stock prices.

On the other hand, maybe Wednesday’s one-way selloff was little more than the herd following each other off the cliff. Few things shatter confidence like screens filled with red and Wednesday’s stumble could be nothing more than selling because other people are selling. Lucky for us, selling without a meaningful catalyst tends to exhaust itself fairly quickly.

At this point, either scenario is equally likely. Fortunately, the two possible explanations for Wednesday’s weakness will quickly diverge from each other. If there were high expectations of a red wave priced into the market, the selling will continue for days and even weeks, pushing us all the way back to the October lows near 3,500. But if Wednesday was nothing more than reflexive selling that got a little carried away, supply will dry up and prices will bounce as soon as Thursday.

Buy a bounce Thursday because it means we are headed to 4k and sell/short a further breakdown because it means 3,500 is just around the corner. It really is that easy.

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