After an organized round of selling last week, the market bounced. That rebound was short-lived and stocks finished on their lows yesterday. Stocks tried to rally this morning and they quickly hit resistance. I believe there is more work to do on the downside.
Global economic conditions are slipping and central bank intervention has not stimulated activity. We need to see growth or this rally will end.
Europe has had six consecutive quarters of negative growth. GDP forecasts for China have been lowered from 8.2% to 7.7% in the last two months. The sequester will keep a lid on domestic growth this summer. I believe economic activity will be flat at best. That might keep quantitative easing in place, but it won’t lead to a new high.
The market can tread water as long as economic conditions don’t deteriorate. Central banks are suppressing interest rates and bond yields are at historic lows. Stocks are attractive on a relative basis and cash flows are at record levels. Companies are using that cash to repurchase shares. This macro environment will allow the market to maintain its current level.
If economic conditions improve, central banks will tighten. Interest rates will rise and the market will face a stiff headwind. It will gradually embrace the move if it is accompanied by economic growth.
My biggest concern is the lack of a global driver. We have a couple of months for conditions to improve. If growth continues to slip, we could see a nasty decline in September/October.
Until then, I believe the market will be range bound during the summer doldrums (SPY $159 – $168). There won’t be much news to drive activity and politicians will disappear. Asset Managers will buy dips, but they won’t chase. After a 25% rally during the last year, the market is due for a rest.
I am not looking for a major decline, but I believe the 50-day moving average (SPY $161) will be tested before the FOMC meeting next week. If that level is penetrated, we will test major support at SPY $159. That was the prior all-time high and now it represents support.
Once this wave of selling runs its course bullish sentiment will be tempered. The market will be able to rally back to the middle of the range and we will chop around for a couple months.
This is a boring forecast, but this pattern is typical. The last few years European credit concerns have created volatility and we won’t have that this summer.
For today, I believe the market will probe for support. As I mentioned yesterday, bullish speculators were caught off guard. They bought the dip and we did not see any follow-through. The rally this morning faded quickly and they will be flushed out in the next few days.
I bought puts yesterday and I will add to my position today if the market goes negative. If I see selling into the close and we are on the lows of the day, I will buy more puts.
If the market closes above SPY $164, I will exit most my put positions.
If we do get a round of selling it will happen now.