Fed Speak the Next 2 Days. Strongest Companies Will Post Results. Reaction Should Be Good.

July 17, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Comments were posted on the open today. The market sold off on Fed comments in June and it rallied back on Fed comments in July. Surprisingly, the message has been consistent during that time frame. Today and tomorrow Ben Bernanke will testify before Congress. His opening statement will be a reflection of the entire FOMC. The market has braced itself for tapering this fall and we should not see a major reaction.

The takeaways from the statements the last two months are such. The Fed will remain accommodative. It believes employment statistics are exaggerated and the economy is fragile. They will continue to purchase bonds, but at a slower pace. The Fed will still be adding liquidity and this is considered to be accommodative.

My concern is that economic conditions are slipping. US employment statistics are padded with low-paying jobs and part-time work. ISM manufacturing and ISM services are hovering above the flat line. Retail sales (ex-autos and gasoline) increased a meager .1% this week. Analysts are lowering Q3 projections for GDP and 1% growth is expected.

China’s trade numbers came in very weak and GDP dropped to 7.5%. Growth in 2013 is at a 23-year low. Their government is satisfied with current levels and they do not plan to stimulate.

Europe’s growth rate has been negative for six consecutive quarters. Analysts keep calling for a bottom, but conditions continue to deteriorate. Unemployment in the EU is at 12.2%. Credit concerns in Portugal are starting to flare up.

Almost 20% of the S&P 500 has revised Q2 earnings estimates. Negative adjustments outnumber positive adjustments by a 5 to 1 ratio. Revenues are expected to grow 1.5% and profits are expected to grow 2.5%. These comps are at multi-year lows.

The good news is that corporate cash flows are very strong. Profits are at record levels and margins have been maintained through cost-cutting. Companies are buying back shares with their cash and that is fueling this rally. I read a report that suggests there are half as many shares available as there were 10 years ago. The float has been greatly reduced through buy-backs and tight supplies translate into higher prices.

Corporations are cautious and capital investments are low. There are too many uncertainties (taxation, regulation, sequestration, global growth and healthcare). Their best investment is to buy back shares.

The US is strong relative to other economies and money continues to flow into equities. Interest rates are starting to rise as Asset Managers rotate out of fixed income and into stocks. This is also contributing to the rally.

This rally is not on sound footing. The strongest companies release early in the earnings cycle and the reaction should be positive. We will get a good sampling this week and I will be keeping an eye on eBay, Intel, IBM, SanDisk, Google, Yahoo, American Express, Microsoft, Honeywell, Whirlpool and General Electric. I believe we will push higher for a couple of weeks and the rally will stall.

I will be buying calls on horizontal breakouts after solid earnings releases. I will stay in the position for a couple of days and I will be quick to take profits. I will also be watching for signs of strain because that will indicate that a top is close at hand. When stocks retreat after posting solid results, the red flag will be raised.

As the market pushes higher the next two weeks, bullish speculators will be lured in. When they are fully invested the market will be set up for a nasty little decline. Profit taking will push the market lower and bullish speculators will bail out of positions. This will force us back into the middle of the trading range.

Asset Managers will not chase stocks at all-time highs when economic conditions are uncertain. Interest rates are rising and they will rotate some money back into bonds. When signs of economic improvement start to surface, they will aggressively bid for stocks. I don’t believe we will see this until September.

Here the takeaways. Trade the rally for a couple of weeks but be cautious and watch for negative earnings reactions. Once they start to surface, look for shorting opportunities. The market will chop around in August and when economic conditions start to improve, we will be ready for a year-end rally.
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