A Perfect Storm: Where the Markets Are Headed and What Actions to Take

by: Hans Wagner
Market action in the last several weeks is signaling that the underlying trend is changing. This is good news, as it will offer new opportunities to exploit the market’s opportunities.
For the last several weeks, the market rally has been getting weary as it kept testing the rising trend. Finally, some surprising news forced more sellers into the market and we have a new ball game for 2010.
The surprise election in Massachusetts told government officials what everyone else already knew. It is the economy and jobs. Two weeks before the election the democrat contender was leading by double digits according to some polls.
Reaction from the U. S. President was swift. He is blaming the awful bankers who caused the problem in the first place.
Claiming that the proprietary trading by the banks caused the recession is not based on fact. An examination of the trading activities of the banks shows their trading activities incurred very small losses. The bad home loans are at the core of the problem.
The reaction from the financial sector was a swift drop in the prices of their stock causing the market to fall through the rising uptrend. A pull back is underway.
Actually, blame for the recession belongs to many. The politicians encouraged homeownership by requiring Freddie and Fannie to buy loans that had no chance of being paid off. Many financial firms created the bad loans and then packaged them into securities that hid the true value of the loans. People applied for and received loans when they had no hope of meeting the payments.
The banking system is sorely in need of better regulation. I do not see how forcing the banks to sell their proprietary trading businesses solves the problem of creating bad loan products, nor does it attack the exorbitant bonuses many receive. Instead, the products should be regulated and traded through exchanges that provide risk pricing and transparency. Higher risk products should come with more commitment of the participants’ equity capital. Transparent trading on exchanges creates competition that will lower prices and reduces unearned returns. This works well for commodities and futures.
The next shoe to drop has bigger ramifications. Fed Chairman Ben Bernanke’s current term expires at the end of January 2010. Senators worried about the upcoming reelection are blaming Bernanke for the recession and lack of jobs.
Changing leadership at the Fed at this crucial juncture is frought with risk. The Fed faces the huge challenge of unwinding the monetary stimulus that helped us avoid a depression. Any wrong moves and the U.S. faces another recession, out of control inflation, or both. Politics and monetary policy do not mix well.
Warren Buffett has expressed his view that the market will fall further if Bernanke is not kept as Fed Chairman.
This perfect storm of the market breaking support levels, and political meddling in the economic recovery, caused the markets to take another step down on higher than average volume. Investors are growing more concerned the economy faces greater challenges with the political conflicts piling up on the struggling recovery.
This leaves us with the question where will the market be in a week, in a month, three months, and the end of 2010. Moreover, what should we do now?

Where we are now

Do not panic. This move down will create new buying opportunities that will be positive for our portfolios. The trend is down, with some support just below. The political rhetoric is likely to continue for another week.
The most important political news item is whether Bernanke is confirmed for a second term as Federal Reserve Chairman. If he is not, it is an indication the Congress is becoming more involved in monetary policy, which is not good for the economy or the markets.
Job growth remains weak at best, though the census hiring will help temporarily in the Spring of 2010. We will get another stimulus bill targeted at creating more jobs. There will be claims it is working, but do not count on it. The U.S. is facing a long-term structural employment problem that cannot be resolved by short-term spending that creates temporary jobs.
Rapid drops by the market are difficult to trade, unless you are a day trader. Trying to chase buy and sell levels during these times usually results in making a mistake. It is better to let your trailing stops do their job and look for good buying opportunities once the smoke clears.

Market Actions to Take
The move down will create good buying opportunities. In addition, the market will act this way for 2010 with pullbacks followed by new rallies as it trades in a range.
This is a good time to tighten your trailing stops using near by support levels as guides. You want to be sure your stop is above your entry, since nothing is worse than to turn a winning position into a losing one.
Close any positions, if worrying about the market causes you to lose sleep. You can always buy back after the pull back ends.
Expect rebounds on weak volume. If you want to sell, use these moves up to do so. For positions you wish to keep, use the weak volume rebounds to add covered calls and protective puts. In addition, any weak rebound will provide an opportunity to buy short ETFs.
Finally, once a bottom is in place, we need to have our list of buying opportunities ready to take advantage of the next rally.

Disclosure: No positions