Dips Will Be Brief and Shallow. SPY $173 Should Hold. Take Profits and Rotate Into Cyclicals

October 24, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Today’s comments were posted before the open. Tuesday, the market surged to a new all-time high. The rally sparked profit taking and stocks look tired after an 8% run in two weeks. Asset Managers will not chase stocks at an all-time high, but they will buy dips.

There are a few issues that will keep profit takers engaged and that means we won’t see a runaway rally. The debt ceiling debate will fire up in another month and that spooks investors. The Fed will change course and taper in 2014. US economic releases are distorted because of the government shutdown and Asset Managers do not have clarity.

From an earnings standpoint, financials have been weighed down by low trading volumes, increasing litigation expenses and a decline in mortgage refi’s. Retailers continue to warn and consumers are tight-fisted. High tech stocks that have rocketed are vulnerable to profit taking. Carl Icahn got the ball rolling when he sold half of his stake in Netflix this week.

If it sounds like I’m bearish, I’m not. I just believe that the market will take a breather. We could see it retrace to last week’s breakout (SPY $173) or it could pull back to September’s breakout (SPY $171). In either case a buying opportunity will present itself.

The macro backdrop is still bullish. Central banks are accommodative and the Fed will not taper until Janet Yellen is in office and the debt ceiling is extended by a year. Republicans have been humbled and they risk losing the House and Senate in 2014 if they continue their current strategy. The next round of debt ceiling negotiations should not be as rough.

Global economic conditions are improving. Flash PMI’s were released this morning and China was better than expected (Europe was a little light). Corporations are lean and mean and any uptick in demand will go straight to the bottom line.

I’ve been saying that the next leg of this rally needs to come from cyclicals. General Electric set the tone last week when it beat estimates. Rio Tinto and BHP posted better-than-expected results early in the week and that bodes well for basic material companies. Railroads (NSC, CNI and KSU) are posting solid results and the stocks are moving higher. Boeing broke out to a new high yesterday and it has a huge backlog.

Today marks the peak of earnings season. Revenues have been flat and profits are up slightly. Balance sheets have never been stronger and cash flows are at record levels. Companies are using that money for M&A and to buy back shares. Any uptick in demand will go straight to the bottom line.

The recent 8% rally is a little frothy and bullish speculators need to get flushed out. The market needs a week to settle down and it will be back on track. I took profits on my positions and I will rotate into cyclical stocks on any pullback. Dips will be brief and shallow.

If you have a 4-6 week investment horizon, you can stick with your longs. Depending on your risk tolerance, you might consider buying some puts for protection. Remove the hedge when support is identified (a test of $171 would be brief and $173 is likely to hold).

Look for stocks that have been in a strong uptrend and are breaking through horizontal resistance. These moves typically last a few days.

This soft patch should run its course in a few days. The meat of this year-end rally will come in the next few weeks.
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