Buying Opportunity, or Beginning of the Storm?

Last week we got an unpleasant reminder of what true fear tastes like. Despite the passage of a debt ceiling compromise that prevented a US debt default, investors offered a rebuke of the process. S&P also pointed to the ineptitude of the political system in the US, using that as a principal reason for downgrading US debt (from AAA to AA+) for the first time in our nation’s history. Perhaps even more troubling to the markets are the increasingly dire straits in Europe.

S&P initially revealed to the downgrade to US officials at around 1:30pm on Friday, but the announcement was delayed because of a simple math error that resulted in an excess calculation of $2 trillion on the US deficit over 10 years. A simple error, but a massive one, that forced the ratings agency to alter its rationale for the downgrade. Frankly, how S&P has any credibility left , after underwriting the crisis and then making this monumental error, is beyond me.

Many believed a downgrade was already priced into the market by the end of last week, but today’s big down open would suggest otherwise. Now, however, it is fully priced in, but it remains to be seen how much panic sets in on Main Street when the markets open this morning. The RSI (21) is at historic low levels, with only 4 occasions of a lower number since 1975.

China is starting to become more pointed with its criticism of the US handling of the debt situation. The rising power said Beijing has every right to demand changes in Washington to resolve debt issues, and that the world needs a new stable secured global reserve currency. Chinese leaders also expressed disgust over the high stakes game of chicken US lawmakers played regarding the debt sealing, joining the chorus of those losing faith in US elected officials. It seems the days when the US could just borrow its way out of many financial problem are now coming to an end.

The European crisis is perhaps the greatest cause for concern at this point. All major world finance ministers, especially in Europe, had emergency meetings over the weekend to iron out how to deal with problems in Italy and Spain. It would take bond buying on a massive scale to head off problems in those two major European economies, and for now it appears the ECB is ready to begin that process.

The huge question in Europe is whether Germany, with its fiscal house in order, will say “enough is enough”. German officials are skeptical about whether, even with a European Financial Stability Facility (EFSF) triple its current size, Italy can be saved. Will the European Union and Euro survive? That is the question in the back of many people’s mind.

Late last week, amid margin calls and a flight to cash, gold sold off with the rest of the market, but surged to a new high once again over the weekend. With large scale bond purchases likely set to begin today in Italy an eventually in Spain, we are once again seeing a flight to the safe haven. The yellow metal made a high of $1715/ounce before pulling off slightly.

The death of 38 NATO troops in Afghanistan during a rescue mission over the weekend–most of them elite Navy SEALs from the revered Team Six–added to the doom and gloom of the weekend. The United States is starting to pay the price on all fronts for excessive spending and hubris, paying a tragic human and economic toll for starting two Middle East wars whose combined cost is well into the trillions and has brought little stability to the region.

The big question now is whether over the last week we got caught in a perfect storm that triggered a rogue wave, or weather this is the beginning of something bigger? In the darkest days, panic and fear drench Main Street and reactions are extreme, but it is important to look at this situation analytically with a level head.

Right now the market is fully pricing in the first credit rating downgrade in US history. The market is pricing in comments from German officials about enormous, potentially unfixable problems in Italy. We are pricing in some troubling economic data in the US, showing that the recovery still has yet to take firm hold. It’s hard to imagine things getting much worse than people are now expecting. I would tend much more toward the buy the dip crowd than the beginning of the end crew.

The question now is whether potential institutional buying will offset panic selling from Main Street. Most agree that many valuations right now are still cheap, but care less about valuations when there is slow economic growth and no significant job creation.

My thoughts are this: it’s possible we could get more heavy selling at the beginning of this week to get the panicked herd out of stock, and then we should get a dramatic bounce at some stage. The amount of fear-mongering out there is disgusting right now. The trajectory of the recovery is still positive and the US is still by far the preeminent player in the world economy.

Panic, fear and volatility create enormous opportunity and enormous risk for traders and investors, and it would be imprudent for amateur investors to try to make bold moves at this stage. My best advice would be to wait things out, and then be prepared to strike in the near future if the carnage continues. If you have a long-term perspective, it would be best to maintain it.

Follow T3Live traders on the Virtual Trading Floor this week, as no matter how you slice it, this type of action is a day trader’s paradise.

By: John Darsie

Disclosure: No relevant positions

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