There Are Two Risks To The Bull Market I’m Watching Very Closely…

It’s becoming challenging, but as I look at the recent market action, I remain cautiously bullish.

Tuesday’s price action was dramatic, with the SPDR S&P 500 ETF (NYSE: SPY) down more than 2%.

But the price action remains bullish for now. A move below last week’s low would be the warning of a trend reversal on the chart. That would be the first time since March that a lower high was followed by a lower low.

If that happens, the price action will reflect the news — which is bearish.

Risks To The Bull Market

There are concerns about a financial crisis in China, and that does look serious. A friend sent me a chart showing that the price decline in Chinese stocks is more severe now than it was during the pandemic.

One theory is that as the global economy shut down in 2020, the Chinese government could contain the economic impact of the Covid crisis. This explains why Chinese stocks, shown here as the iShares China Large-Cap ETF (NYSE: FXI), fell about 27% while the S&P 500 dropped more than 35%.

Now, Chinese property developer Evergrande is at risk of defaulting on about $300 billion in debt, and FXI is down more than 30%. This decline may indicate traders are less confident about the government’s ability to manage a financial crisis.

In addition to China, Congress is facing a deadline and needs to act quickly. As The Wall Street Journal reported

Treasury Secretary Janet Yellen told Congress that the Treasury would be unable to pay all of the government’s bills if lawmakers don’t raise or suspend the federal borrowing limit by Oct. 18.

“At that point, we expect Treasury would be left with very limited resources that would be depleted quickly. It is uncertain whether we could continue to meet all the nation’s commitments after that date,” she said in a letter to congressional leaders on Tuesday morning.

This could be the most significant debt ceiling battle since 2013 when a similar deadlock led to the United States losing its AAA credit rating. However, there is time for Congress to reach a solution. There is also some time for Congress to reach a deal to fund the government past September 30, when the current fiscal year ends.

Closing Thoughts

While the debt ceiling and budget battle are serious issues, they are unlikely to cause a sustained bear market. The Federal Reserve admitted it developed a plan after the 2013 crisis and much of the government stays open even during a shutdown since essential workers stay at their jobs.

China, too, may not be a significant crisis, at least at first, in the United States. Banks seem to have limited exposure, and the debt crisis that Evergrande faces was seen for some time so those with risk had a chance to implement mitigation strategies.

So, I remain cautiously bullish that the news will not create a financial panic. But for this week at least, I’m choosing to remain on the sidelines and will make no new trades.

I use a high standard to minimize risks in my trade recommendations. My risk models indicate that the risks of selling options are unusually high, and no trades passed my screen this week. I expect to have additional opportunities next week, but earnings season is also approaching, and that could add to the uncertainty.

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