Take Profits On Puts – News Was Not That Bad. When the Bounce Stalls – Reload

June 6, 2013

Many years of trading have taught me to be flexible. Conditions change quickly and news that was once considered bullish suddenly generates a bearish reaction.

This is the heaviest selling we’ve seen in 2013 and I believe the market is transitioning. I’m not looking for a massive decline, but a normal 10% correction is likely.

In prior months, lackluster economic releases have been bullish. The market is addicted to easy money and sluggish growth kept the printing presses running. Now, sluggish growth is viewed differently and we seem to be in a no-win situation. Weak economic growth will reduce corporate profits. Strong economic growth will force the Fed to taper.

From my perspective, the unpredictable reactions to news releases signal a transition. The market is due for a pullback. I am not looking for anything nasty, just a 10% correction.

We need strong economic growth. This will reduce quantitative easing and interest rates will rise. Initially, the market won’t like it, but over time, it will embrace the move. I don’t see us reaching this point for a few months. The sequester is keeping a lid on economic growth. Once it runs its course, activity should regain its footing.

I can’t view bad news as good news and I am always suspicious of rallies that follow that logic. Deteriorating economic conditions are bad for profits. Employment is stable at 150,000 new jobs, but it is not keeping up with the labor force. We need at least 250,000 jobs and we have not come close to that level this year. ISM services and ISM manufacturing are treading water.

From a global perspective, China’s growth is slowing (7.7%) and the EU is dismal. Every analyst keeps calling for a bottom in Europe, but we have not seen an uptick in activity.

Central banks have been printing money like mad this year. However, China does not have any stimulus plans; Japan is going to take a rest and the Fed hints of tapering. Sooner or later, the punch bowl has to be taken away. If economic expansion is underway, the market will rally even when central banks are tightening.

Credit concerns are not an issue. That can change quickly, but PIIGS yields are stable. The EU is moving towards a centralized banking authority and that will calm nerves.

This has been a strong eight-month rally and the market made a new all-time high. This trend will be very tough to turn. We are overdue for a normal correction and I believe we will see one over the next month.

Typically, normal corrections during long-term uptrends have this pattern. The market will fall for two or three days and then it will bounce. Once that recovery stalls another wave of selling will begin and there will be a series of lower highs. Keep in mind that Asset Managers still want to get in. They will nibble during these dips and that will spark short covering. Eventually, the market will establish support and the long-term uptrend will resume.

There will be shorting opportunities, but the sell-offs will be short and swift. You have to be nimble. Do not overstay your welcome and take profits when the selling pressure is heavy. Also know that once support is established, a longer term buying opportunity will present itself.

The key right now is economic activity. China needs to stabilize and we need to see an uptick in Europe. Domestic conditions will improve once the sequester runs its course. If global growth continues to slip this summer the decline will exceed 10%. Economic releases didn’t mean much last month, but they will carry more weight now.

I believe the selloff is a little overextended and Friday’s Unemployment Report will come in around 150,000. That number won’t mean too much. Asset Managers are not ready to throw in the towel and we will see some nibbling. That should produce a nice bounce and we might make it back to SPY $164. That was previously a support level and now it is resistance. Once that bounce runs its course, we are likely to test major support at SPY $159.

I sold out of my call positions during the last two days and scratched. When we took out the lows from Monday I bought puts yesterday. I’m not seeing any follow-through selling is morning so I am taking profits on my put positions.

I will be day trading today from the long side. Look for a rally the next few days. When it stalls buy puts.
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