Super Committee Likely To Admit Defeat, What's Next?

Includes: SPY
by: Eric Kelly

Surprise, the super committee is reportedly set to admit defeat this week, according to a Bloomberg article. The group which was assembled to explore and enact ways to cut spending and raise revenue has essentially been a waste of time. The politicians that made up the group have not been able to meet in the middle for the better, with the most likely roadblocks being Bush tax cut issues and Medicare.

Equity markets have been reacting violently to headlines and currently feel top heavy to most traders and analysts. The news that the super committee has failed is not a shock to most, but the fallout and string of events may ignite a push lower in equities.

The failure to come to an agreement means the U.S. Congress is still unable to effectively do its job. The country, and world economy due to globalization, is dependent on U.S. legislation to help it emerge from the recession.

The real problem will be if Standard & Poor's decides to downgrade the U.S. again. Fitch has also mentioned a looming downgrade. We have seen that the ratings company is quick to pull the trigger and has some internal reporting problems as evidenced when a false alarm was sounded on French debt last week, so be prepared for a quick and not-well-thought-out reaction. The potential U.S. downgrade would reiterate the problems with lawmakers' inability to accomplish goals, deal with deadlines, and how a massive complex government is seemingly working against itself. Certain members of the super committee are already publicly admitting they expect the automatic cuts to kick in, as Senator John Kyl stated on "Meet the Press," so its just a matter of time at this point.


So where is the trade in all of this?

The equities market had a nice run-up earlier in November, setting the stage for sell-off conditions, especially since all of the fundamental problems still exist that caused the drawdowns in recent months. The market has also displayed abnormally small amounts of volume on both up and down days. The volume will even lower this week due to American holidays and European fears. These observations lead me to believe that a strong downside move is very possible and that market participant confidence is extremely low (heads up on another Flash Crash).

My feeling is that the market will move lower through November and December. With volatility as high as it has been, traders may find it difficult to buy expensive SPY puts, which is a safe risk-controlled way to play this. My strategy will be to sit in cash in anticipation of piling back in at lower prices. Normally a trade recommendation involves a long or short position, but this time the goal is conserving capital and timing re-entry.

Although it's clear I'm bearish short-term, I highly recommend against taking an outright short position. If the super committee comes to any kind of small agreement or Europe releases anything resembling a plan to deal with its debt situation, the market could rally into the New Year.

Cash, cash, cash.

S&P500 11-18-2011. One year daily chart.

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