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At the Fed meeting last week, Jerome Powell used some code words to warn us to watch out for downside ahead.
Powell told us that he's the tough hombre that will stick to tight policy until there's "a significant and lasting correction in the markets." That certainly means more than a measly 10% correction, or even a fast 20% decline. Earlier in the press conference, he alluded to the idea that a housing bust is a much more serious threat to the economy than a mere stock market decline. So it's pretty clear there will be no Powell Put for the stock market. Powell is warning you to be prepared to take some pain.
Furthermore, the Fed will only BEGIN to reverse policy AFTER a big market decline. The first steps toward ease never create a bottom. Stock prices continue to fall in the early stages of lowering rates and priming the pumps. Remember 2008? The Fed started lowering rates in 2007. The stock market didn't bottom until 2009. The S&P 500 lost 57% of its peak value while the Fed was lowering rates.
We've had enough warning. The market has been generous to those who hung onto their stocks despite the warnings. Those who stayed in have been rewarded again and again. Alarms have been sounding, and the market has kept rising. That's how manias behave.
Now, the alarm has been sounded again. The late-day sell-off in stocks on Sept. 26 was a recognition of that by some traders. It brought the market to this rally's trend line from the June low.
Closing below that line and below 2,900 would be a sign that this would be a good time to buy a few at-the-money puts on the SPY, expiring in about a month, to take advantage of the downside that's likely to follow. These puts would give you tremendous leverage to profit from the downside, including the potential for triple-digit percentage gains. But remember to limit your trade to no more than you'd be willing to lose if we are too early again and the market extends its rally.
And if you're not already mostly out of stocks, let Powell's words at the meeting serve as a reminder that the time is growing short to do so. If you choose not to sell, then at least use puts to cushion the portfolio losses that are sure to come.
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Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.