On Friday we discussed the four possible outcomes for the S&P 500 index relative to attaining a new high above the 1565 mark. The one scenario of never attaining this level currently, and the index reversing to test lower, was given the smallest probability. Based on the weekend developments following Friday’s brief selling, it may be the more likely outcome as we start the week of trading with a new twist. Cyprus unprecedented plan to levy bank deposits has unsettled market around the world. It has sparked a flight to safety and the dollar is up along with the VIX index. This brings to the forefront yet another news event that will impact the market indexes short term.
Thus, our scenario of a reversal and not eclipsing the highs currently is in play. The S&P 500 index futures are down 1% or approximately 15 points currently. That may change by the open, and it will certainly change as the trading day unfolds. Thus, the question, how do we deal with this event? As I stated in the post… know before an event what the plan/strategy will be before it happens. Since we have our stops in place, we step back take a deep breath and study the impact of the event.
Is this a long term impact? Will this impact the economic markets ability to produce growth relative to earnings and revenue? Is there a specific sector that will be impact the most? What options do we have relative to the event? Along with many other questions.
There are no way to answer all of these questions currently, but the data will surface going forward that will give us answers and insight into each as it unfolds. As with most events it will produce an initial overreaction and then logic will begin to take over and the opportunities will arise. The one issue that will arise from this issue is the uncertainty of how governments will act on individuals assets. As stated, this is unprecedented, and it will change the view of many depositors around the world. The potential “run on the bank” scenario becomes a greater possibility unless something is put in place to assure depositors confidence they will not lose their personal assets.
The financial sector is likely to take the biggest hit today. Watch how the big banks react to this news. They just got a vote of confidence from the Fed on the stress test last week and now this will put some of that fear back into play. The sector is down more than 2% in pre-market pricing. That is the initial reaction, how it unfolds will be important.
Fear is the one issue markets deal poorly with and the VIX index will show some measure of that in trading this week. Watch to see how it unfolds. I am not worried about the initial reaction as much as how it develops during the week going forward. If fear rises and remains in place the downside risk of the market short term will rise with it. Remember, the sentiment has been building towards the markets being overbought short term. This ‘event’ gives logical reason for those who wanted to sell… to sell. The news from Cyprus is just a potential catalyst to what was already building.
The best course of action is to see how this plays out, manage the risk and make the necessary adjustments to stops. Time will tell how this plays out and most important, it will provide opportunities going forward. If you are too focused on the negative, you will not see the positive. This is why we plan and manage risk daily… you never know what will happen while you are sleeping.