Next Week Could be Huge

Does it really matter that markets are overbought technically using a variety of indicators? How about the fact that investor sentiment is at levels historically associated with near term market tops? Is it a concern that corporate insiders are selling their own company stock at near record levels? If the future is so bright, why are insiders selling so heavily? Has the market factored in more “quantitative easing” than the Fed is likely to propose? Will the election outcome, however it turns out, excite or disappoint investors? All these questions and more, most likely will be answered by mid next week.

It is not hyperbole to suggest that next week may turn out to be the biggest week of the year for Wall Street. On its own, the market should have a significant pull back. However, with the makeup of the legislature and the purchase of some unknown quantity (possibly trillions of dollars worth) of bonds on the line, we could have some real fireworks go off by this time next week.

It is said that markets are discounting mechanisms. They move in advance of any news, supposedly factoring in a predetermined result. I believe that is true except in cases of market tops and market bottoms. For example in 2007, in the age of excess liquidity, most investors were hardly planning for the real estate debacle that ensued, causing a severe recession. In March 2009, most investors were seeing continued gloom and doom, only to have the market rally. Since the end of August markets have been rallying on the notion that bad news is good news and that the Fed will ride in on a white horse (or helicopter) and purchase about $1,000,000,000,000.00 in assets.

If the Fed follows the Japanese model from a couple months back, those assets could include not only bonds, but real estate, stocks, and ETF’s. Technical factors such as being overbought, excessively bullish sentiment, among others, may be overwhelmed by such a windfall of newly printed cash. On the other hand much of these long anticipated decisions may have already been factored into today’s current prices and the only result could be disappointment from the actual facts. The old adage has always been to “buy on rumor and sell on news.” If that holds true, we could be set up for a drop.

The recent tight trading range on the indices, up against their major resistance levels, as well as internal divergences, suggests a significant breakout move is at hand. As usual, it is the direction of the next move that is not very clear. Investors most likely will have to wait for next week’s key events to gauge the market’s reaction. I believe the recent highs and lows on the S&P 500, offer critical pivot points that will present the direction participants are searching for. Above 1220 or below 1159, after next Wednesday, will most likely determine the markets next near term move.

Acting as a buffer to the downside going forward are few key elements. One is that the Fed will announce some sort of support to keep markets from crashing more than a healthy pullback. Also the calendar is favorable. The “sell in May and go away” cycle is replaced by its bullish opposite which is to buy in November and hold into spring. In addition, the third year of the Presidential four year cycle, has historically offered the best returns for market investors.

One negative potential factor that could come into play is that traditionally mutual funds lock in their trading profits before Halloween to create a taxable event for the fund holder in the same year. However, profits taken after October are not taxed until the following year. Are mutual funds sitting on a host of profits that will result in sales starting soon?

Next week is huge for news that will affect the markets in the near and long term. It will be very interesting to see which way we go. Watch the pivots and protect your capital.