Maintain A Slighltly Bullish Bias Until Earnings Season – Then Pivot!

This week, I have suggested that the market could continue to move higher, but you need to be very cautious. The volume has been light and the rally has been influenced by quadruple witching. As traders sense a directional move, they execute buy programs and then short covering adds fuel to the fire. The market has been able to get back above the 200-day moving average. Earnings season is a few weeks away and during the last three quarters we have seen a rally before the announcements begin. I believe prices will trend higher the next few weeks, but the party will end soon. The big issues that loom (credit crisis, political instability and double-dip recession) need time to manifest. This morning, the Philly Fed showed deterioration in manufacturing. This is consistent with the Entire Index that was released on Monday. During the last year, inventories have been rebuilt from unprecedented levels. In 2008, businesses could not access short-term funds to buy supplies and they were desperate for goods. That cycle has run its course and it provided a nice pop for our economy. Jobs are still an issue. This morning, initial jobless claims rose 12,000 to 470,000. This is a very weak number and the four-week moving average is starting to climb. May's Unemployment Report showed that the private sector is not hiring. We are completely dependent on government jobs for growth and they will start decreasing in a few months. Stimulus programs have run their course and state and local governments are cutting payrolls to balance budgets. The austerity programs in Europe are a joke. Minor cuts will not materially reduce deficits. As the economic activity declines, deficits will grow and the bond auctions will fail. This might take a few months to unfold, but interest rates across the EU are already starting to rise. During the last three quarters, stocks have pulled back once earnings season is underway. If guidance is cautious, a selloff will result. The decline in each of the last three quarters has been more pronounced and there's a good chance that support at SPY 104 will fail. For the time being, sell out of the money put spreads that expire in July. These positions should be safe since earnings season will just be getting started. Any rally between now and then will give you plenty of cushion. As implied volatilities contract, you should scale into (buy) longer-term put positions (September through November expirations). Once the selling begins, we know that Market Makers jack up implied volatilities and they widen out bid/ask spreads. This makes it difficult to make money once the selloff is underway. By taking longer-term put positions, you can hanker down and ride out some of the whipsaws. By this fall, I expect to see sustained selling. We will see a series of lower highs and lower lows. For now, keep your distance and maintain a slightly bullish bias for the next few weeks. Be ready to take bearish positions once earnings season begins. The next big move is down.

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