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Market Continues to Surf Despite Tsunami Warning


The market's pricing the odds of US debt default at 0%.

People become desensitized to certain things rather quickly. The market now appears to have become entirely immune to the debt ceiling crisis (or debacle, or whatever term you prefer). To illustrate why this happens psychologically, I need look no further than personal experience.

Since 2009, my family and I have lived in Maui, Hawai'i, and in the years we've lived here, there have been maybe a dozen tsunami scares. I vividly remember our first big tsunami scare, since my adrenaline was pumping for hours. We were awakened by the tsunami warning sirens at 6 a.m. on a Saturday morning, so we rushed off to the grocery store to stock up on essentials like water, batteries, Rolos, etc.

The tsunami warning center said the first wave would arrive at 11:19 a.m. We drove to high ground, where we'd have a good view of the ocean, and I sat there with my camcorder at the ready, anxiously awaiting the arrival of the first big waves. As the clock ticked down, I turned on the camcorder and zoomed in on the beach. To everyone's amazement, precisely at 11:19 a.m. almost to-the-second -- exactly when scientists said it would arrive -- there was nothing. So we watched and waited some more. Then we got hungry and went home to watch the local news. Then we took naps, because let's face it, who gets up at 6 a.m. on a Saturday? As it turned out, that tsunami was a complete non-event.

The next tsunami warning we experienced was slightly less exciting, but still tense -- but it also turned out to be a non-event. By the third, the routine had become old hat (and I had amassed a stockpile of water and canned goods already, so no need to rush to the store anymore). While there was still a little bit of nail-biting, I think the sentiment was best summed up by my wife who remarked, "Yeah, whatever, that's what they always say." And it was indeed another non-event.

Ever since then, we've been pretty much immune to the drama. And while we're not willing to completely throw caution to the wind like some folks (out here, you often see locals walking the beaches and surfing while the sirens are blaring), we really don't get too worked up about it anymore.

It's a mathematical certainty that one of these days, the warnings will actually pan out and a devastating tsunami will hit our shores and wreak havoc with our infrastructure. But in the meantime, we've become largely desensitized to the whole thing.

I think America has collectively reached a similar psychological footing in regards to the debt crisis. Nobody really believes anything will come of it.

And maybe it won't. If we're really lucky, our leaders will decide on yet another "temporary" increase of the debt ceiling, so we can do this all over again in a few months. That certainly seems like the most likely resolution, since it would allow the government to solve the problem by doing what it does best: nothing.

Regardless of outcome, I find it interesting that the market seems to be pricing in the odds of US default at essentially 0%.

ConvergEx Chief Market Strategist Nicolas Colas recently wrote:

If there were even a 1% chance of a Treasury default, the VIX (TSE:VIX) would be over 20 and stocks would be retreating, not advancing. Too much of the world's financial system is predicated on Treasuries as 100% reliable collateral to believe anything else. Russian roulette with a 100 chamber revolver is still too dangerous a game.

So the market is not only saying that default won't happen, it's saying that it can't happen. I think watching the market rank the default potential at 0% bothers me for the same reason I'm bothered when I see people surfing during a tsunami warning. Yeah, I agree, odds are good that probably nothing will happen -- but the odds are still most definitely higher than 0%. Anyone who's studied quantum mechanics and is familiar with the Heisenberg Uncertainty Principle knows that the odds are never 0%, any more than they can be 100%: simply nothing in the physical universe can be quantified with those levels of absolute precision.

Still, I realize there's no sense in trying to preach the Morality of Odds to the market -- as John Maynard Keynes famously said: "Markets can remain irrational a lot longer than you and I can remain solvent." In other word,: the market's gonna do what it's gonna do, and it really doesn't care whether we judge it as careless or not.

So the market is clearly front-running a positive outcome with the latest rally. That sort of front-running can sometimes create "sell the news" events. If too many investors get on board with something before it happens, then there's not enough folks still left to buy after it happens, and sellers take over.

Here's an interesting chart of the Nasdaq Composite (INDEXNASDAQ:.IXIC). Last time I published this stock chart, I anticipated a rally, but also expected we'd later see a retest of the low, due to the RSI readings at that low. Nasdaq instead went on to overlap the key bearish price point, which suggested a new high -- which it has since narrowly achieved. But the question posed by RSI still remains: Can bulls cheat the odds entirely here? Obviously it's not impossible that they could -- I can't predict the future, I can only examine the past and try to anticipate based on what the odds suggest is likely from prior examples.

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Financial stocks continue to lag the broad market, which hasn't been particularly bullish in the past. Note that so far the Philadelphia Bank Index (INDEXCME:BKX) is simply testing the black resistance zone.

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The S&P 500 (INDEXSP:.INX) remains within the multi-month noise zone. A new high isn't out of the question, but presently, I would expect a correction to follow soon after. Bears like to feel downtrodden about the stock market (seems to go with the disposition to a degree), but they might ask themselves the following question: How many bulls have bought those last two breakouts to new all-time-highs, and how are they feeling after two immediate whipsaws?

If the market does sustain trade above the previous all-time high, then next resistance is indicated in the 1740-1750 zone. On the bearish side, there's a small potential head-and-shoulders forming on the SPX 5-minute chart, which suggests a trip toward 1680-85 if 1695ish fails.

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In conclusion, as I noted last week, I'm not closed to more bullish options. But all I can work with is what's in the charts right now -- and there are a few things still suggesting that bulls aren't out of the woods just yet. Trade safe.

Follow me on Twitter while I try to figure out exactly how to make practical use of Twitter: @PretzelLogic.

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