Why an optimist loves this week’s selloff

Free After-Hours Analysis: 

The S&P 500 shed another -1.5% Tuesday as last week’s fear trade comes roaring back.

Last week, it was the Fed telling us they will keep interest rates higher for longer than most investors were hoping for. This week, fear of a U.S. gov’t shutdown/default is adding to the pessimism. Of course, none of these headlines are new or unexpected, and this weakness simply reflects the never-ending swing of sentiment.

While it is hard to watch these losses pile up over the near-term, most investors knew these things were coming, so we shouldn’t expect a significant repricing of stocks based on widely known and expected headlines.

Sure, the US could actually default on its debt this time, sending the global economy into a tailspin. But we’ve been down this path so often that very few investors actually believe this will happen. Number one, this latest round of equity selling won’t turn into anything significant because the consequences of default are too dire and a budget deal is coming. But number two, if the unthinkable actually happens, the consequences are so dire a 20% crash in stock prices wouldn’t be enough.

That turns this into the infamous black swan trade. It most likely won’t happen, but if it does, it will be bad!

Lucky for us, we are nimble, independent traders, and we can pull the ripcord long before markets fall 20%. In fact, I pulled the rip cord last week and have been watching this week’s carnage from the safety of the sidelines.

As much as I want to buy these discounts, savvy traders don’t buy the dip, they wait for the bounce.

If history repeats itself, as it almost certainly will, Republicans and Democrats will eventually come together and save us from themselves at the eleventh hour. And more than waiting for this bipartisan agreement, stocks will rebound days, even weeks, before a deal is reached, so savvy traders are following the market’s price-action and not waiting on the headlines.

The market is in a bad mood, but like all bad moods, it will eventually improve. The only question is when.

We didn’t get a bounce last week, and we’re not getting one in the first half of this week, but that doesn’t mean it isn’t going to happen. While my inclination is to buy this oversold tumble, I need to see the selling capitulate and bounce first. That simple requirement is saving me a truckload of money this week.

Maybe prices bounce in the second half of the week, or maybe it doesn’t happen until next week. But as long as I wait for capitulation and the inevitable bounce (and keep a nearby stop), any false buttons won’t be a problem. More importantly, I stay alert and ready to go because the market loves symmetry and the inevitable bounce will come hard and fast. Wait a few hours too long, and you will miss a big pile easy and fast profits.

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