Price Action, Sentiment Favor Bulls, But What If Something Goes Wrong?

by: Benzinga

By Scott Rubin

The stock market has turned decidedly bullish over the last couple of weeks, as stocks surged earlier this month after hitting a new low for 2011. The rally has brought the S&P 500 back to the top of its multi-month trading range, and it would appear that many traders and money managers are looking for the market to trade higher into the end of the year.

This thesis, however, relies on some sort of resolution to the crisis in the Eurozone.

Reports indicate today that European governments may approve a bailout fund of up to $1.3 trillion to fight the debt crisis by combining the temporary and permanent rescue funds. German Chancellor Angela Merkel and French President Nicolas Sarkozy are asking Eurozone leaders to assess a "comprehensive and ambitious" package of measures at a summit on October 23, according to Bloomberg.

At the latest, these measures would be agreed upon by October 26. There appear to be snags, however, as Angela Merkel canceled a planned speech to parliament in Berlin tomorrow as a result of disagreements over the bailout proposal.

“It's a disappointing development but without any concrete proposal for increasing the efficiency of the fund the chancellor can't present a complete set of proposals tomorrow,” Norbert Barthle, the ranking member of Merkel's Christian Democratic Union party on parliament's budget committee, said to reporters.

Sources indicate that the French want more money from Germany, and that the Germans are unwilling to meet the demands. If this hangup becomes a major hurdle in the coming days, one has to wonder what the consequences will be in global financial markets. A lot of stock has been accumulated during the recent rally on the hopes that this bailout fund will be a solution to Europe's problems. It stands to reason that if something were to fall apart at the last minute, the buying could turn into selling in a heartbeat.

Given the overall bullish sentiment and the extreme trajectory of the recent rally, any kind of reversal could be fast and very steep. Many portfolio managers have been taking off hedges in VIX and ETF options and a lot of short sellers have been forced to cover.

As a result, if something unexpected were to happen, we could see portfolio managers who are not sufficiently hedged begin to liquidate positions in a panicked fashion, with the lack of short-sellers covering positions in a decline (buying) intensifying the move lower.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.