Was 1,075 on the S&P 500 the low? I believe that this is highly unlikely. The forces that have been pushing the market down since late July are nowhere near resolving themselves. Let us review briefly.
1. Crisis in Europe. The European crisis has two principal dimensions. First, there is the sovereign debt crisis of peripheral nations. Second, there is an emerging banking crisis that is a derivative of the sovereign debt crisis. There are many institutional and political impediments to implementing the necessary solutions. Thus, threat of a full fledged sovereign debt and banking crisis in Europe should continue to haunt the market for several months before the Europeans are ultimately forced to come together to take the decisive steps necessary to save the EU.
2. Fiscal crisis in US. The US is utterly divided politically regarding how to deal with its fiscal problems. It is unlikely that Super-Committee in the US will be able to come up with any kind of solution until the last moment, and even then the solutions proposed are likely to be insufficient.
3. Threat of global recession. The above crises in the developing world have seriously damaged consumer and business confidence around the world. This has caused a loss of economic momentum that threatens to tip developed economies into full-fledged recessions, with potentially disastrous consequences. Weakening demand in the developed world is being reflected in sharply slower economic activity in developing countries such as Brazil and China. Brazil’s economy appears to be in contraction mode. China’s economy is apparently in the midst of a significant slowdown and due to severe imbalances built up in the economy, it will be very difficult to engineer a “soft landing.”
None of these problems will be solved immediately. It is my expectation that the above forces will continue to exert downward pressure on global markets and the US equity market specifically (^GSPC, ^DJIA, ^IXIC, ^NDX, SPY, DIA, QQQ) for the next two to four months, at minimum.
Thus, I believe that it is highly likely that during the course of the next 2-4 months, the 1,075 level on the S&P 500 will be tested and likely violated on the way to my target area of around 950-1,020 on the S&P 500.
It is my expectation that the current rally in the equity market will exhaust itself at either the 50% or 67% retracement levels on the S&P 500. These levels correspond to 1,154 and 1,180 level on the S&P 500, respectively.
I purchased November SPX puts at the close on Wednesday with the S&P 500 near 1,142. I would stop out of the position if the 1,155 level were surpassed on the upside. I would reinitiate the position above 1,170 with an ultimate stop level at around 1,190.
I believe that investors should take advantage of this rally to lighten up on stocks and/or initiate short positions. I believe that attractive stocks such as Apple (AAPL), Microsoft (MSFT), Intel (INTC), AT&T (T), Verizon (VZ), Pepsi (PEP) and Goldman Sachs (GS) will be available for purchase at prices 10% to 20% lower than current levels.
Disclosure: I am long SPX puts.