Yesterday’s Reversal Is Not Bearish – Normal Shakeout. Back Drop Is Bullish. Wait For A Better Entry

November 8, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

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I wish I had posted yesterday’s comments an hour after the open as I normally do. The tone would have been much different.

The market had been consolidating and the ECB rate cut was the type of news we needed to force a breakout. Minutes after the opening bell, the selling started to build and it was obvious the move would not hold.

My intentions were to monitor the rally and to build to 50% of my normal position if the rally gained traction. I never got the chance and once the downward momentum started, I knew we were in trouble. When the SPY breached $177 I bailed on my call positions. I did take a loss, but the damage was relatively contained.

In yesterday’s comments I mentioned that the volume has been very light. We needed to see a breakout, follow-through and volume.

Some analysts said the ECB rate cut was a “sell the news” event. I completely disagree. Only about 3% of economists expected a move. A surprise central bank rate cut is typically very bullish and European stocks rallied on the news.

I believe the negative reaction had more to do with deflation in the EU. This is the first rate cut they’ve made in a long time and the move was sudden. Japan has thrown the kitchen sink at deflation and it could become an issue in the EU if they don’t get ahead of the curve.

I also believe our stronger-than-expected GDP number (2.4%) sparked selling. Strong economic growth will move the tapering timeline closer. This morning we learned that 204,000 jobs were created in October. That was much better than expected and tapering concerns remain elevated.

The market needs strong economic growth if it is going to move higher. Sooner or later, the Fed will have to remove the training wheels. Every parent wants their kids to learn how to ride without training wheels and they expect a few scrapes along the way. The sooner the Fed starts to taper the better. The market was already prepared for it in September.

Unfortunately, tapering won’t happen before 2014. I don’t believe the Fed will wait for Janet Yellen to take office and for the debt ceiling to be extended by a year. When the Fed does reduce bond purchases, they will probably lower the unemployment rate target as well.

The Fed conducted a study earlier this week that suggests that the target unemployment rate should be lowered from 6.5% to 5.5%. That would mean that tightening is many years away (2017).

Retail sales, ADP, Chicago PMI, ISM services, ISM manufacturing, global PMI’s, GDP and the Unemployment Report have all come in better-than-expected. This is a very bullish backdrop.

Politicians have kicked the debt ceiling can down the road and it won’t be an issue for at least a month. Republicans were humbled during the last round of negotiations and Democrats are struggling with the Obamacare rollout. I believe the next round of debt ceiling negotiations will be less contentious.

Analysts are maintaining their earnings projections for the S&P 500 this quarter. Cash flows are at record levels and companies are using that money to buy back shares.

We are in a seasonally strong period. Asset Managers won’t chase, but they will buy dips.

Yesterday’s move flushed out bullish speculators (me included). We will probe for support this morning and we could still see a little selling. Support at SPY $173 should hold and I am a buyer at that level.

I’ve been mentioning that I am trading a fraction of my normal size and I have been maintaining tight stops. Trading breakouts is relatively straight-forward. You enter on the breakout and you stop yourself out if it is breached.

Growth stocks have been pounded. They got a little frothy and bullish speculators needed to be flushed out of these names as well. There might be some nice scoops when the dust settles. Look for chances to buy when major moving averages are tested (100 and 200).

We should also see some rotation out of growth stocks and into cyclicals. I like transportation and basic materials companies.

The damage should be relatively contained today. The backdrop remains very bullish and I’m looking for an opportunity to get long. There is no need to rush it.

The selling yesterday is a sign of resistance. It will be harder to penetrate $178 the next time around and the breakout will be much more significant.

I don’t believe the SPY will get back above $176 today, if it does I will buy a few calls. I am ready to add on a breakout above $177.

Don’t let yesterday’s reversal spook you. This was just a normal shakeout and it will result in a better buying opportunity.
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