Market Does Not Like the Yield Spike. Profit Taking Will Set Up One More Good Buy

Posted 8:30 AM ET (Pre-Open) -The market is digesting a major round of economic news. We are likely to see a little profit-taking near the all-time high. Stocks need time to gather strength and this soft patch could last a few days. Yesterday we learned that GDP climbed 4% in Q2. This was much better than expected after a 2.9% decline in Q1. The market rallied on the open and it gradually drifted lower throughout the day as interest rates moved higher. ADP reported that 218,000 new jobs were created in the private sector during the month of July. This number was in line with expectations and it is much lower than the 288,000 that was reported in June. Analysts are expecting 220,000 new jobs when the Unemployment Report is released tomorrow. Initial jobless claims have been falling during the last month and that suggests a good number. ISM manufacturing will be released tomorrow as well. The consensus estimate is a reading of 56 and that is very strong. Economic conditions are improving and we might be entering a phase where "good news is bad news". Interest rates will start moving higher even though the Fed plans to stay accommodative. Bond Managers will start adjusting duration, but they won't pick up the pace until September. Yesterday's FOMC statement was benign. The Fed continued to taper and it cited that structural unemployment issues warrant accommodative monetary policy. They are in recess and the next FOMC meeting is on September 16th. The last thing they wanted to do was to spook the market and I expected a dovish statement. Earnings season has climaxed and two thirds of the S&P 500 companies have reported. Revenues are up 5% and profits are up 8%. These are excellent results and the guidance has been generally optimistic. Companies are lean and mean and any uptick in demand will go straight to the bottom line. Asset Managers did not participate in the light volume rally that started in May. They wanted proof that an economic recovery was underway. Now they have it and they are playing catch-up. That means the bid to the market should remain strong. The market won't like the trend reversal in interest rates. So far, every bond selloff in the last six years has found support and shorts have been humbled. I don't believe this battleship can be turned at this time. As we get closer to the September FOMC meeting, interest rates fears will start to build. That means this little spike in yields should be contained and we should still have a few good weeks for the market. When the Fed ends its bond purchase program in October, the focus will immediately shift to tightening. Their balance sheet is an unprecedented level and we don't know how smoothly the “great unwind” will go. The market will eventually adapt to higher interest rates, but in this case it will take longer than normal and we could see large spike or two. Credit concerns remain low, but Argentina technically defaulted last night. The market does not seem overly concerned. Perhaps that is because they suspect that bondholders will agree to a haircut. Global credit markets are intertwined and I don't take any of these defaults likely. One seemingly small failure could have a ripple effect. ISM services will be released next Tuesday and we will also get retail sales next week. Apart from that, the calendar is light. Earnings season is winding down and DC will be in recess. There is a lot of news to digest. I believe it is still too early for a full-blown bond selloff. The Fed gave a dovish statement yesterday and that should contain the bleeding. The economic news has been good and earnings are excellent. The market will hit a soft patch for a few days and support will be established. We will make one more run at the highs. This morning, the market is testing support at SPY $196. If that level fails we will test $195. That is the 50-day moving average. I am day trading from the short side. If the market bounces immediately, we will know that Asset Managers are still engaged. On the other hand, if the market takes a long time to find support, we will know that the bid is deteriorating and that a meaningful correction lies ahead. Once support is established, buy calls and maintain tight stops. When the position is profitable, move your stop up. We should get one more nice run at the high, but this rally is in the 9th inning. . .

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