The rhetoric in the past was that markets shrug off all bad economic news as it potentially indicated higher probability of QE3 being delivered. Therefore, bad economic numbers was good for the market as it implied higher chance of the Fed providing liquidity to stimulate the economy which would, in turn, drive asset prices higher.
The GDP numbers are the first major economic data point in the post-QE3 world. The following possibilities exist
- Data disappoints, markets sell off - Opportunity to buy on decline with SL
This would indicate that the market looks at the present set of bad data as a confirmation of the poor earnings in the US. The recent sell off would be justified and would see another 2-3% downside to the markets before support levels are reached and bullish sentiment awakens again. Having already corrected, a degree of resilience will be built into the market.
- Data disappoints, market close firm/rally - CAUTIOUS..play the momentum buy short at higher levels
This would indicate that the underlying sentiment continues to remain quite bullish and the markets will are actually in a 'buy-on-dips' zone where traders are looking to buy stocks in anticiptation of higher prices despite the poor earnings. Its a dangerous zone to be in. One should trade nimbly while watching downside risks very closely as markets could crash even at the smallest disappointment from leadership changes or changes in the situation in the Middle East.
- Data positive, markets sell off - Opportunity to buy on decline with SL
Divergence between corporate profits and GDP growth. One will eventually track the other. Given the presidential elections, Chinese leadership change, etc, it indicates that the markets are in a cautious zone and might correcti
- Data positive, markets rally - BULLISH
In this scenario the markets are probably going to remain in an uptrend, recapture their recent high, and potentially make a newer high. The sentiment can change to one believing that QE3 is working. This can add 7% to 10% upside to the SPX.