Basically what we’ve got is that Italian stocks are declining – and they have been for a while – at the same time that U.S. stocks have been rising.
Normally, U.S. stocks and Italian stocks have a positive correlation and sometimes one of them will catch up with the other by rising, so you’ll actually get a correction in favor of risk appetite, but that’s rare. In my experience, and when I’ve done some work on this particular problem, I’ve found that about 75% of the time the price correction happens in favor of fear, meaning that the S&P 500 should be expected to decline.
Again, as I said, that’s not 100% but it is a pretty solid ratio. The last time things really got like this was almost the same time in 2012. We had prices rising on the S&P 500. In fact, if we basically look at what happened from the beginning of February 2012 through essentially the end of April 2012 on the S&P 500, it was a still a mild rise in price while we saw the Italian stocks down quite a bit. Sure enough, we finally did get a correction in favor of risk.
So, this is what we’re watching very closely at SlingShot Trader – us and everybody else – because the real question here is because Spain and then Italy – I don’t know that you can prioritize one over the other – because they’re next in line for a bailout, are they going to do the same thing in those economies that they did in Cyprus?
Cyprus is inconsequential. It doesn’t really matter, but what it does do is signal what the European Union is likely to do in these bigger economies. So, if they were to confiscate deposits, for example, from Spanish banks and Italian banks, you’d see a flight to quality really fast. In other words, you’d see a flight of capital out of those economies and that would be disastrous for those stocks, which would, in turn, also be a bad thing for global stocks, including here in the U.S.
So, we are watching this really closely. It’s not something we can say, yes, this is happening or it’s going to go down. So far, the primary trend has been really strong on the S&P 500, but this is an important enough development in the market that we are watching it very, very closely to justify why we want to take profits a little early, especially out of bullish positions.
Investor Place advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.