In my article, “Time To Cover Shorts?,” published yesterday, I wrote the following:
It is my belief that in trading, stops and limits must be set not only as a function of price but of time. One must give an investment thesis a set amount of time to play out.
For me, that time limit is this Friday. If the market is not below 1,170 by tomorrow and exhibiting downside momentum I will take off all bearish positions.
My investment thesis was that the market would react badly to August data published in September. My call regarding the August data was a very good one. August data published in September was indeed terrible. It is the reaction to the news that hangs in the balance.
From the outset, I have set this Friday as a deadline to see if the market ultimately reacts badly to the bad economic news, or whether it remains more focused on the hope that policy makers can figure out a way to avert recession. Friday is a key date. I will either stop out of bearish positions or I will maintain them and possibly increase them.
I mentioned that the market had rallied in anticipation of Beranke’s and Obama’s speeches. It remained to be seen whether those speeches would cause investor focus to shift from worrying about the gathering economic crisis to thinking about potential solutions to the gathering crisis.
Bernanke’s speech said nothing that had not been said in Jackson Hole. Obama’s speech said nothing that would lead investors to believe that his jobs plan was credible.
Thus, with the opportunity to focus the public and financial markets on potential solutions squandered, the focus is back on the problems.
Last week I mentioned that there could be two catalysts which could cause downside momentum to pick up: The crisis in Europe and profit warnings. As if on cue, there was significant bad news on both fronts on Friday.
First, Jürgen Stark, European Central Bank executive board member, reportedly resigned over disagreements regarding sovereign bond purchases by the ECB. As I wrote here, ECB bond purchases are ultimately the best hope that Europe has of averting a full blown crisis. In this context, deep political divisions over this issue are obviously not a positive development.
Second, as I highlighted here, Texas Instruments (TXN), the world’s largest maker of analog semiconductors, cut its third quarter revenue guidance by 5%9% - a very significant loss of momentum. Given that 89% of TXNs revenue is from non-U.S. sources, this tends to show that economic growth momentum is slowing globally at a very alarming pace. TXN’s warning followed those of other semiconductor companies such as Altera (NASDAQ:ALTR) and Fairchild Semiconductor (FCS), earlier in the week. Thus, the weakness is not isolated. Indeed, TXN management indicated that weakness was across the board in all product segments – a clear sign of a general loss of macroeconomic momentum.
With the market strongly penetrating my threshold level of 1,170 to the downside, both fundamental and technical momentum favors the short side trade going into next week.
What To Watch For Next Week
I would expect a continued downward bias to trading up until a week prior to the next Fed meeting.
In my view, the main factor that could cause the market rally would be hints by Fed committee members of specific stimulus actions. Signs of progress by the Super Committee could also be well received. Similarly, bipartisan cooperation on a jobs bill could also be well received by markets.
On the downside, I see significant potential for more deterioration in Europe as Greece’s situation becomes increasingly untenable. The problem is that the EU has no real contingency plan to deal with a default by a member country. Watch the 6.0% yield level on Spanish and Italian bonds. A spike beyond that level would likely spark mass liquidation of stocks globally.
In the U.S., more revenue and profit warnings could be in store. If semiconductor companies are seeing slack orders, it is likely that this is an indicator of slack sales by producers of finished goods.
Finally, keep your eyes on China. China’s economy is highly export-dependent. I fully expect bad news from the next reports of Chinese economic activity. This will likely cause another severe downdraft in the commodities complex and stocks and ETFs linked to this sector such as Freeport McMoRan (NYSE:FCX), GSCI, IEZ, FXI and MOO.
I am watching stocks such as Microsoft (MSFT), Apple (AAPL), AT&T (T), Verizon (VZ), Vodafone (VOD) and Goldman Sachs (GS) with keen interest. However, I believe that these stocks will be available at prices 10%-20% lower than they are currently.
Technically, the 1,120-1,100 area should be watched with keen interest. A break of this level could result in accelerated liquidation and acceleration toward my target area of 1,020-950.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long SPX puts. I am short TLT and long TBT and SBND