Another Black Swan and a harbinger of things to come?

Fellow Friends and Traders,

No sooner did our Thanksgiving turkey get digested when world markets suffered indigestion. They choked on Dubai's sovereign debt. While we enjoyed a holiday closed session, most world markets suffered a 3% decline overnight. I believe this was the biggest 1 day decline since April '09.

The world's credit debacle over the past few years was truly a "Black Swan" event of the 1st magnitude. Dubai hardly qualifies as one but we all remember others that started small and insignificant currency or financial crises that then wreaked havoc on world markets in the past. This will impact oil producing countries in the Middle East and European banks more than the U.S.

However, we should all be worried not only about the default itself but about the possibility of Dubai's sovereign wealth fund having to sell off assets in a hurry to raise liquidity. A lot of the assets in question are UK commercial real estate, a further fall in the prices of which could be painful all over especially the US and in China.

Could little Dubai become a harbinger of things to come? Moody estimates the total stock of sovereign debt worldwide will rise by nearly 50% between 2007 and 2010 to $15.3 trillion. Most of this debt will come not from irrelevant little states but from major economies like U.S, Europe and Japan. Perversely, these same countries are the key beneficiaries of the "flight to safety". Could these currencies cause an unwinding of the risk carry trade that has made so much money in '09? Stay tuned.

Even after our sharply lower opening Friday, the market like a Timex watch keeps taking a "lickin’ but still keeps tickin’". Why you may ask? Answer: "The Market Play Book".  You again ask what's that?  I have observed that over the last 49 years of financial turmoil the FED has always bailed us out. How? Through lower interest rates is the answer.

At the start of any recession, economic weakness, financial debacle, whatever the cause, investors rush from hard assets, real estate and finally stocks into fixed income especially Government bonds.  This is equally true for these last few years.

Remember the March '09 bottom? No one wanted hard assets or equities. As interest rates and stocks declined bonds enjoyed a substantial rally. Most domestic pension plans, endowments and even insurance companies have a balance between equities and bonds. The decline in stocks and the rally in bonds after awhile distort those ratios. Eventually these fixed ratios must be maintained for those institutional investors. They must then sell bonds and buy stocks etc. This is nothing more than "asset allocation" that's talked about in the "The Definitive Trading Bible".

This asset reallocation out of bonds into equities is what's most likely the primary driver of this year’s late and continued rally and has nothing to do with fundamentals. This is most likely to end for most institutions by December 31st. Then, I'm waiting for "Joe Public" to sell his bonds and buy equities once more then I'll know the top is in or I hope so.

Friday's call trade and Chart of the week:

Our option expiration trade always works best on Friday. Why? Because expiring options are basically throwaway trades. Your reward/risk is outstanding when your option trades for $0.50 or less. You only have a 1 point E-mini risk on the downside but you are totally open-ended on the upside. Last Friday the market opened down nearly 31 S&P points lower or -3% like most world markets did the previous day. Today, most overseas markets were better. Start your engines. 

Enter your orders before the market opens because the market is going to open @ or near the 40% buy from the Nov 2nd low and the 20 DMA. The market also opened at 2.3 Uni Band that have contained 98% of price movement in most markets over the last 28 years. The 50 DMA is only 7 S&P points lower. Go for it! This is a great tenet # 3 buy made even better with cheap expiring week options.

In two hours the market rallies back to a multi-day 60% sell 1098 and back to the lows where support becomes resistance. Sell all calls!  The throwaway OTM 510Ws (Weeklies) go from $0.25 to $2.20. The better ATM 505Ws calls go from $1.50 to $7.00. See linked 30" weekly chart. Yes you could buy the E-minis and make $1,000 on a $500 investment or a 2X return. But why, when the risk is open-ended and not just $50 per option contract. Cheap expiring options are still the best game in town!

Since we had a 60% rally off the lows our trading range lives for awhile longer bounded on the downside by the 20 and 50 DMAs, 1114ish on the upside and the multi-year downtrend resistance line. Remember this is still a bull market. The declines are sharp and fast. Enjoy the ride ahead.  Just watch the sign posts and stay in touch with New Era Trader.

I hope you all had the best Thanksgiving and are now looking forward to a healthy and happy holiday season.