Last week, the market pulled back to the 50-day moving average and support held. The jobs report on Friday was better than expected and stocks rebounded.
A few weeks ago I felt that we would pullback, flush bullish speculators out and rally to a new all-time high. Now I am not so sure.
Previous declines have been marked by a single “bad day”. After a couple of days the market would retest that low and then it would slingshot to a new relative high. These dips were resolved in a matter of days.
The decline the last two weeks was organized. There were a series of down days and the volume was relatively heavy. I believe we are seeing some profit taking.
Domestic economic conditions will struggle as fiscal spending cuts take their toll. China and the EU are soft. China’s economic numbers were little on the light side and exports came in at 1% (7% expected). Many analysts have been calling for a bottom in Europe and there are no signs of life. In terms of economic activity, I believe growth will be flat this summer.
If conditions suddenly improve, interest rates will pop. The Fed says that they will remain accommodative, but the market won’t wait for them to take action. They will start selling bonds well ahead of time if activity improves. If economic conditions improve (unlikely), the market will face a headwind (higher interest rates).
We want economic growth. The market might not like the initial spike in interest rates, but it will eventually embrace the move. If job growth can get to 250,000 this year, the market will make another new high. This has been a very sluggish recovery and that is a tall order.
If conditions do not improve, record cash flows and strong balance sheets will still keep the market afloat. The Fed will remain accommodative and money will gradually flow into stocks. This is a much less desirable scenario because the rally would be artificial. We need a global growth engine.
The news will settle down this week and the summer doldrums are about to begin. The next big event will be the FOMC meeting 10 days from now.
Technical support was tested and it held. The market rebounded and we are back above SPY $164. I believe we will trade in a range between SPY $159 and $168 for the next two months.
The rally has been focused on stock valuations relative to bonds and central bank intervention. That focus will shift to economic releases. No growth – no rally.
I am currently on the sidelines. I will day trade if the market looks overextended or if we get an intraday directional move. I will not buy calls, but I will buy puts if the SPY trades below $164. Bullish speculators that bailed during the last decline are right back in. If sellers decide to reduce risk, the market will drift lower and they will get shaken out again.
I’m not looking for a massive market decline and I don’t believe we will rally to new highs this summer. There will be some volatility within the range. The market needs to consolidate gains from this year and it needs to gather strength/information.
We will see rotation and there will be opportunities to trade individual stocks. Keep focusing on horizontal breakouts.