Last week the market pulled back on a light round of profit taking. Bullish speculators were flushed out and tapering fears returned. Asset Managers do not want to chase stocks at an all-time high, but they will buy dips.
In recent months we’ve seen a few reversals off of new all-time highs. The declines have been brief and shallow. Stocks did not bounce last week, but they did find support.
Only 20% of analysts feel that the Fed will taper on Wednesday. However, more than 70% believe that they will set a firm timeline (January or February). When they do start tapering, they will do so gradually. I am also expecting them to lower their jobless target rate. In doing so, they will strengthen their commitment to ZIRP (zero interest rate policy). We need to get this tapering monkey off of our back and the Fed has an opportunity to cast an economic vote of confidence on Wednesday.
If the Fed sets a target date, the market will pull back on the news – it will snap back quickly. On the other hand, if they do not take any action and they do not set a firm date, the market will rally. That spike will be short-lived, just like the one in September. The market is prepared for the news and the Fed would be foolish not to deliver. Traders want to get this out of the way so that they can move forward.
Congress is close to a budget deal. This is a positive development and it is one more reason the Fed might feel comfortable enough to set a target date. Republicans want to stay out of the headlines and they will extend the debt ceiling without much of a battle in Q1. The GOP senses that Obamacare will implode and they believe they will win the House and the Senate in 2014 if they just keep their noses clean.
China’s flash PMI was a little soft (50.5 versus 50.8). However, government officials said that the growth target for 2014 is 7.5%. Many analysts feared that they might lower it to 7% and the news was bullish.
The flash PMI in the EU was much better than expected (52.7 versus 51.5). Activity has been slipping recently and this was welcome news.
Corporations have been buying back stock at record levels. On a daily basis, 6.4% of the volume is buyback related. I recently read a study that suggests that 50% of all outstanding shares have been repurchased in the last 10 years. Simple economics dictates that if demand remains constant and supply contracts, the price will go up. This fact alone explains the 25% rally this year.
Earnings season is over and growth was flat. However, profits and cash flows are at record levels. US 10-year treasury yields are below the dividend yield on the S&P 500. Stocks are attractively valued.
European credit concerns are low and EU is forging a centralized banking authority.
Seasonal strength will attract buyers. The volume will remain low and I am expecting a gradual grind higher after the Fed statement.
This is a low probability trading environment. Asset Managers won’t chase stocks after a 25% rally this year. They will buy dips, but they won’t get overly aggressive. Some Asset Managers will take profits if the market gets overextended. I don’t believe we will see a massive rally, but a move from current levels to the all-time high would produce nice gains.
The easy money has been made. Keep your size small (20% of normal).
I am buying some calls today and I am using SPY $178.50 as my stop. I will add after the Fed statement.
We are building on early gains and this looks like a positive day.