The markets still are largely digesting the big post-election
sell-off, but it's not so much the reelection of President Barack
Obama that's got everyone onWall Street nervous. Rather, the
biggest source of tensions fraying the nerves of traders is the
potentially disastrous hit oureconomy could suffer if the
administration and Congress fail to come to some type of meaningful
agreement on the so-called "fiscal cliff."
As you likely know, if the powers that be in Washington, D.C.,
drive us off the fiscal cliff (which simply is a term for the
poisonous cocktail of automatic spending cuts to crucial sectors
such as defense, and automatic tax increases), the impact of that
crash landing will be felt very hard on Wall Street. Last week,
markets tanked due to the realization that a failure to resolve our
budget issues could cut a $600-plus billion slice out of the
nation'sGDP pie.
In fact, the selling on Wednesday and Thursday of last week
drove stocks down sharply, and for the first time in quite awhile,
exchange-traded funds (
ETFs
) pegged to the inverse of the major U.S. averages were among
themarket 's top performers.
Now, on the other side of the globe, there also is a looming
change of leadership, but it isn't likely to come with any vigorous
debate or disagreement over budget issues. Here I am referring to
China, as a new cadre of Communist Party leaders will assume the
reins of the second-largest economy in the world.
To be certain, the Chinese economy has had a tough time in the
past 12-18 months, as there's been a slowdown in its rate of GDP
growth from the double-digit percentage growth a few years ago.
Most recent GDP data shows the Chinese economy growing at a rate of
7.4% in the third quarter, the lowest growth rate since early
2009.
However, other metrics of late have improved, including the
purchasing managersindex and trade data. Together, these numbers
suggest an economy that's no longer sliding, and this stabilization
has been reflected in the rising price of Chinese stocks since
September.
I suspect that the fast money is ready to continue migrating to
China for gains, while at the same time moving away from domestic
equities, at least until the uncertainty over the fiscal cliff has
been taken off the table.
Smart traders can take advantage of this with a pair trade that
is long China and leveraged short the broad market S&P 500
index. Here are the particulars of the trade as I see it:
iShares FTSE China 25 Index (
FXI
)
This is a fund pegged to the top 25 stocks on the Shanghai
Exchange. Icall FXI the "Dow industrials of China," as these are
the behemoth companies that trade on that country's exchange.
Since the September low, FXIshares are up nearly 12%. I suspect
this fund could see another big spike past the February highs of
$40.49 on optimism over new leadership, as well as pessimism in the
United States over the fiscal cliff, and the ever-present bailout
andrecession issues still plaguing Europe.
Action to Take -->
Buy FXI at themarket price . Set stop-loss at $33.53. Set
initialprice target at $40.50 for a potential 13% gain by year's
end.
ProShares UltraShort S&P 500 (
SDS
)
Buying this fund is a bet that the fiscal cliff issues will result
in a flight of capital away from U.S. stocks. SDS is designed to
deliver performance that's equal to twice the inverse of the
S&P 500 index, so if the S&P 500 falls 2%, SDS should rise
4%.
Because of its leveraged nature, I don't recommend holding this
fund for more than six weeks or so, but that's perfect given the
fact that the fiscal cliff issue has a deadline of Dec. 31. I
suspect that the fast money will continue pouring into this fund to
gain some short-termalpha , and that's awave you also can ride to
higher gains.
Action to Take -->
Buy SDS at the market price. Set stop-loss at $52.75. Set initial
price target at $65 for a potential 10% gain by year's end.
This article originally appread on TradingAuthority.com:
The Trade Everyone Should Make Before the Fiscal
Cliff Deadline