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As the Euro Tragicomedy Continues With Cyprus, What Should Traders Do?


Traders should not jump in and buy the open with both hands, but rather stay focused on how the drivers of the current bull market behave.

As we awake to a Cyprus "surprise" and down arrows across the board, my focus remains on the tells that have driven this market since we came off the March 2009 lows. I described them in some detail in Corporate Bonds, Derivatives, and How They Wag the Equity Markets and while the "bank raid" concept adds a new twist to the European tragicomedy, it's hardly the first time this has happened. In fact, near and dear to my heart, Italy experimented with bank raids a number of times (see In Favor of Italy's Berlusconi Resigning? Be Careful What You Wish For), and even under the Mario Monti regime the option of such a maneuver was only shelved after the government decided to whack everyone with a real estate tax on primary residences, a much more far-reaching tax considering north of 78% of Italians own their primary residence.

The fear, of course, is that "bank raids" can lead to "runs on banks", and if Germany is willing to put its foot down on Cyprus, who's to say that it won't happen in other "more meaningful" countries; if that concern spreads, already shaky banks in Italy, Spain, Greece, and so forth could see all sorts of capital flight.

In my humble opinion, these concerns are rationally legitimate, but practically overblown. The EU/ECB (i.e. Germany) has shown time and again that its bark is far worse than its bite (how many "this is the last Greek bailout" have we had so far?). Just as Ben Bernanke's tools to exit our eternal QE are morphing into a single option (letting the Fed's balance sheet run off), the "tough reforms" that Mario Draghi vaguely discussed as a pre-condition to the Outright Monetary Transactions ("OMT") (the commitment to monetizing anything that walked if that's what is necessary to safeguard the euro) will also morph into …nothing, and the ECB will step in and buy anything and everything to keep the Ponzi scheme going, austerity notwithstanding. I tweeted last night (@FZucchi if you care to follow) that the key question is not if/when the Cyprus "bank raid" will be implemented, but rather when will Germany reverse its demands, apologize for imposing conditions on bailouts, and promise it will never do something like this again.

So, does it mean that traders should jump in and buy the open with both hands? Of course not. For weeks now I've pointed out various DeMark buy exhaustion levels on different time frames. But the power of this year's move has been such that all those levels were regularly overrun. On a daily and weekly basis, the S&P 500 (INDEXSP:.INX) is within the influence of Perfected TDST Sell Setups; and on a monthly chart it is just one bar away from completing a Perfected TDST Sell Setup and a Countdown Combo Sell (see Interpreting DeMark Indicators: All Trends Must End, But the When Is Key for a primer on these indicators and how to use them). In other words, seeing the market run out of steam shocks me far less than watching it continue to tear higher. A pullback to SPX 1501.48 – the daily TDST Level Down – wouldn't even qualify as a meaningful correction, and as long as the SPX stays above 1398.11 – the weekly TDST Level Down – the bears better keep their snouts shut and work hard to rebalance their books for the next rip higher.

Notwithstanding how deep and scary the correction will be – and it may not even be here yet for all we know – the more important point is to stay focused on how the drivers of the current bull market behave. The corporate and bond derivative markets are due for a rest. If spreads widen some across asset classes, it won't mean the end of the financial world. The longer term key is whether these pullbacks and higher spreads will be treated as "buying opportunities" by corporate debt buyers. If yes, then this will be yet another equity dip to buy. Should we start seeing the corporate bond market truly unravel, then we will have to reconsider. Seeing as in the current seasonally slow time for the bond market $34 billion of new bonds were sold last week, and that on Friday – typically there's almost zero issuance on the last day of a trading week – almost $7.5 billion of new bonds and preferreds were sold, the onus to show that this pullback will be different remains squarely on the bears.

Also see:

Cyprus: Has the Next Phase of the Global Crisis Arrived?

Position in SPX
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