Markets Like Stability

Markets can handle good news and even bad news. What the stock market abhors is instability. Investors can deal with the status quo; they loathe change.

An example is the surprise left-wing coalition surge in the recent election in France that blocked Marine LePen’s quest to bring her far-right party, National Rally, to power in the National Assembly. As a result, French stocks turned higher. Why? Because no single group secured a working majority. That means that likely not much will get changed.

Closer to home, after the Trump/Biden debate, the SPDR S&P 500 ETF Trust (NYSEARCA: SPY) dropped a bit until the mainstream media recognized Biden’s alleged debate loss and accepted a probable Trump win, suggesting his presidency would be good for the market. Even if Biden were to be reelected, we may well see a divided government, which all but assures not much gets done on this side of the pond either, hence a rising stock market.

Analysts uncovered three divided-government outcomes with a statistically significant relationship to market performance. The following two scenarios corresponded to positive absolute returns in excess of long-term average results: a) Democratic control of the White House with full Republican control of Congress, and b) Democratic control of the White House with split party control of the Senate and House.

The one, albeit unlikely, scenario that corresponded to modestly below long-term averages is a Republican control of the White House with a full Democratic control of Congress.

In general, markets respond to possible individual and corporate tax policies and spending priorities, especially in energy. Potential changes in infrastructure and defense, future programs such as Social Security, Medicare, Medicaid and health care, including the future of the Affordable Care Act, will also influence markets. Investors are concerned about regulations, immigration policy, geopolitical conflicts and China, including the potential for additional tariffs. The likelihood of changes in these areas will affect market prices.

These days, markets are highly sensitive to the future of interest rates in the near term, as evidenced by Fed Chair Powell’s recent testimony of strengthening confidence that inflation is moving sustainably toward 2%. With his testimony, SPY continued to hit record highs. He even mentioned that inflation need not actually hit the 2% mark for him to consider lowering interest rates. This comment shot SPY up several points, instilling even more confidence.

How does all this affect day trading SPY options? Even as we determine short-term trends, we still like to keep a watchful eye on longer term market direction. I recently consoled a gentleman who had purchased 100 put options “because SPY was at the top of the chart and could only reverse back down.” I really could not decide which argument to attack first, his ignorance of how charts expand to accommodate the price action or his lack of understanding of how fundamentals govern longer-term market trajectories. I explained how, if I was in his shoes, I would seriously think about cutting my losses, even though he was down considerably. This would not even qualify for a repair as the odds were totally against SPY dropping in the time frame he needed it to go.

With the imminent election of Trump as the GOP front-runner, markets are feeling the positive vibe and are already positioning for his presidential win. During his previous presidency, the Dow made 126 new highs. To keep perspective, since Election Day, and up until his inauguration day, Biden saw the sharpest gain on record in the S&P 500 of 12.8%. This confirms the theory that markets like to rise in election years. They feel that either winner will lead to some positive move.

We look at events and conditions such as these in our Trading Room. Securing an overall feel for the market direction and sentiment is critical to success. Then, if SPY counters that direction, we consider it a pullback or retracement, with an eye on the overall orientation, and start looking for the ideal time to enter a position. This is just one of the many things we discuss. Education is important, but acting on that knowledge of fundamentals is key. The longer you spend in the Trading Room, the better trader you will become.

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