Stock Sell-Off Coming? Some Perspective

by: Danny Riley

Full year ahead

What history tells us may end up something different than what the bears want. The sixth year of a bull market can be powerful, but with so much time in the year traders have the mindset that the markets will go lower. The paragraph below is from a 40-year veteran of the futures and options markets.

From a friend

Most of the traders in the room are much shorter-term oriented than I, so I don't pipe up much but did want to make this comment - a significant correction is close at hand. I have a T that calls for mid-Feb top; the one-year, four-year presidential and decennial composite cycle has a mid-April top; the Bradley standard has its big turn in July; or the decline could begin today. We don't know but its shadow is here. Every trader in this room, even the most bullish, should have some kind of put position tucked in the back of his/her portfolio right now. Trade from the long side if you want but keep the put position on. When the sell-off comes the volatility is going to jump way before prices get ugly and it will be harder psychologically to buy puts. Hang on to the position if you can. Odds are you will make more money with it than anything else you do this year.

Another point of view

John Paulson

This year will likely prove exciting for the stock market. Perhaps the S&P 500 will reach as high as 2000 before succumbing to a correction returning it close to where we begin the year. Isn't it just like the stock market to turn more difficult just as most are finally beginning to return to stocks for the first time in this recovery? While it may be enjoyed by traders or timers, we suspect it will prove quite challenging and frustrating for most investors. Compared to the bond market, though, a flat stock market may represent a safe haven.

Remaining optimistic

Most importantly, perhaps, investors should remain mindful that while 2014 may prove challenging, we are not likely facing a major inflation risk, and we will likely survive beyond the Fed beginning to tighten monetary policy.

While we may pause in 2014, the stock market probably still offers considerable upside beyond this year.

It's our guess that at some point the S&P will get hit, but we agree with Paulson that the S&P could trade as high as 2000 either early or late in the year. With so many speculators guessing the S&P can go down in the near term, we have to go back to being a contrarian, at least in the near term.

The Asian markets closed lower (except Seoul) and in Europe eight of 12 markets are trading higher. This week's economic calendar includes 19 economic releases, 10 T-bill and T-note and bond announcements and auctions. Seven Fed governors speak, and we'll get the Fed minutes and the jobs report.

Today's economic calendar starts out with the Gallup U.S. consumer spending measure, factory orders and the ISM non-mfg. index.

Our view

Mondays are not a good day for the S&P, and based on Friday's close we expect to see lower prices. Sometimes things become a foregone conclusion and with the S&P futures holding under fair value, index arbitrage computer programs (a major driver of price action) have many sell stops building up below which could lead to a selloff.

  • In Asia, 10 of 11 markets closed lower: Shanghai Comp. -1.80%, Hang Seng -0.58%, Nikkei -2.35%
  • In Europe 7 out of 12 markets are trading higher: DAX +0.22%, FTSE+0.05%
  • Morning headline: "Bearish start leads to sell-off speculation in stocks"
  • Total volume: 960k ESH and 5.9k SPH traded
  • Economic calendar: Gallup U.S. consumer spending measure, factory orders and the ISM non-mfg. index and a 3- and 6-month T-bill auction
  • E-mini S&P 5001821.00-4.50 - -0.25%
  • Crude98.55-0.22 - -0.22%
  • Shanghai Composite0.00N/A - N/A
  • Hang Seng22684.15-133.129 - -0.58%
  • Nikkei 22515908.88-382.43 - -2.35%
  • DAX9431.45-3.70 - -0.04%
  • FTSE 1006735.57+4.90 - +0.07%
  • Euro1.3646