The market is not out of the woods yet. U.S. elections will take center stage on Tuesday and many experts believe the outcome has largely been priced into stocks (meaning an Obama victory). The chatter this morning is that if the Democrats sweep it could pave the way for higher taxes. The spin on this is that it would not be good for the market.

The “big news” this past week was that the Fed lowered interest rates to 1% and world banks are lowering their rates as well. All of this is intended to stimulate a sagging global economy but we are looking at several quarters before we see any significant improvement. The problem has not been liquidity and the cost of money, but the willingness to lend is just not there. Investors and banks are hoarding cash.

Which leads me to the hedge fund industry. I’m not sure if this possible bomb is priced into the market but we better prepare for it. The industry is poised for a massive shake-up as investors demand the return of billions of dollars from both struggling and even funds that have posted positive returns. I’m hearing that anywhere from 750 to 1,000 hedge funds could be closing shop by year’s end. Yikes.

The squeeze on hedge funds from the credit crunch goes hand-in-hand with what makes many of them successful. If you recall, we had a recent ban on short selling instituted by the Securities and Exchange Commission as a result of the credit crisis which eliminates an important trading tool for hedge fund managers. The credit tightening itself also limits their ability to use credit to add leverage. While it’s not yet clear how many investors have submitted redemptions or will be liquidating their positions over the next few months, it is something worth watching.

The Dow is trading higher by 26 points to 9,350 a half hour into trading this morning. The index held support at 8,000 last week which was slightly higher than the 7,773 October 10 low. After an initial move down at the open, the Dow is looking to test 9,400-9,500 today.

A close above those levels would signal a new pattern of “higher highs” and could lead to a push towards 10,000. It has been hard to trust this market but it does appear that we might be carving out a trading range up until Thanksgiving. However, I wouldn’t go out and buy just call options. I still think its best to have both call and put options in your portfolo as some sectors look strong while others continue to look awful.

Try to buy put options on rallies and call options on declines like we did with the casino stocks. Also keep in mind that the volatility may have subsided for the time being but it will be back. The Volatility Index (^VIX, 58.43, down 1.46) is still quite high but has come down from a high of 90 as the market has rallied.

Historically speaking, if the VIX is at 30 or more then it means the market is nervous. If the VIX is under 20, the market is confident. It’s not clear what the “new” standards should be for the VIX because the volatility has also been historic. However, as I mentioned earlier, the market still has some issues that it needs to deal with before we can consider this a bull market.

Rick Rouse