I Expect A Retest of SPY 80 Before Option Expiration – Support Should Hold!

Buy the rumor, sell the news. The promise of a revised bank bailout artificially supported the market last week. It was able to shrug off a horrible Unemployment Report. In the last year, a very predictable pattern set in and traders were able to get short ahead of the most critical piece of economic data each month. As the Unemployment Report approached, investors would nervously unload stocks and the market would decline. In the last two months, this pattern has been broken and it was getting a little "too easy". Last week, anyone who went short got squeezed when the market rallied. It looked as though a strong bid was supporting the market, but I believe it was a short covering rally. There is no way that one man's financial bailout plan could have restored confidence. The new Treasury Secretary revealed his plan. In essence, $500 billion will be used to purchase toxic assets and $1 trillion will be used to beef up bank balance sheets. He said that the plan needs to be flexible and that they will make mistakes as they battle the largest credit crisis since the Great Depression. The stimulus plan that was supposed to be a slam-dunk last week has stalled in the Senate. Politicians are negotiating the terms of the package and a ceiling around the $800 billion level seems likely. Almost 40% of the funds will be used as tax credits. The House and Senate are finding it easier to agree on tax credits then on spending. This compromise is no doubt the result of the incredible stimulus we saw from last year's tax rebates – NOT! People are worried and they will not spend their tax credits. For the first time in 20 years, the savings rate is actually rising. Consumption is down and people are planning for tough times ahead. I don't see how giving each taxpaying citizen $400 is going to create 3 million new jobs. However, I can see that it will greatly increase our budget deficit and it will jeopardize our country’s AAA bond rating. President Obama wanted to add back the education part of the plan. Unfortunately, politicians agreed that the $40 billion had to be reallocated to state aid. States are in bad shape and that will be the next shoe to drop. As their tax revenues decline their budget deficits will grow. For years, states have been running in the red and that is escalating now that unemployment is on the rise. The dramatic decline that we saw yesterday was momentum selling. There really wasn't any new information that caused the decline. Once the momentum set in, buyers stepped aside. In today's chart, you can see the big declines. The market makes many small advances over a number of days and then one or two big declines bring it back to support. Conditions are dire, but I believe the support level will hold for the time being. Traders will want to see if any of the initiatives during the last year are starting to work. Since most of the nervous money and speculation has been washed out of the market, I believe big declines below support are unlikely. As the government rolls out its plan, the demand for US treasuries will be critical. Once investors have their fill of US debt, the cost of capital will start to rise. The Fed has talked about buying treasuries to keep interest rates low. If that happens, we could see stagflation. It is the worst of all trading environments. Economic conditions deteriorate and inflation rises. For today, the market is trying to recover from yesterday's debacle. I believe it will probe the downside this afternoon but not in a big way. Tomorrow's initial jobless claims number will create anxiety this afternoon and tomorrow. It came out much higher than expected last week and the unemployment rate is accelerating. Retail sales will also be released tomorrow morning and that is another dark cloud the market will have to deal with. Once we test support at SPY 80, I believe the market will find its footing. With the SPY trading near its one-month low, option expiration is likely to have a negative bias. We need to get through next week with the current support level intact if we are going to continue to “mark time” at this level. I sold into yesterday’s decline and I have my desired short put exposure. If the market breaks below SPY 80, I will be buying back puts on stocks that are close to breaking support levels.

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