Politicians May Give Us an Enormous Buying Opportunity

The S&P 500 fell 2% yesterday, and the Nasdaq lost 2.6% as a broad sell-off engulfed the stock market. Uncertainty over the inability of politicians to put together a deal on the debt ceiling before the Aug. 2 deadline was blamed for the decline. But a weak June durable goods report and increased risk inEuropecontributed, too. Selling accelerated sharply after CNBC reported that someone at the Treasury Department said there was were no funds to payU.S.debt interest beyond the deadline despite an earlier report that funds existed, and the White House appeared confused as to when an agreement had to be reached.

The Treasury’s story was later denied, but by that time, the S&P 500 had violated its 50-day moving average, and MACD issued a sell signal spreading fear among traders that a broad breakdown was about to occur. Decliners exceeded advancers on the NYSE by 7-to-1, and volume picked up to over 1 billion shares extending a trend of increased volume

Fear has finally entered the market as measured by the CBOE Volatility Index (VIX) and two recent gaps up. But gaps up often occur during periods of high emotional stress and usually precede a market bottom. The spike in the VIX in March was preceded by several days of gaps culminating in a sharp spike in the index to over 31. This washout resulted from irrational fear but provided investors with the best buying opportunity of the year.

As noted in yesterday’s Daily Market Outlook, the president and the Republicans will eventually sign a deal, since no one wants to be blamed for the potential losses that could occur if an agreement is not reached. But if the politicians monkey around with the debt-ceiling issue until the final hours of Aug. 2, the world’s fear factor could exceed all expectations. And the S&P 500 could test not only its 200-day moving average at 1,282, but might even dip below the support line at 1,260 giving us the greatest buying opportunity since March.

If you are a nimble day trader, you should be shorting the hourly rallies. But as mentioned yesterday, earnings are strong, and so investors should work up a list of quality stocks along with prices that they would be willing to pay on an extreme but short-lived sell-off. Keep your powder dry. The best bargains are yet to come.