Overnight Risk Greater Than Reward. Big News This Week. Surprise Favors Downside.

April 29, 2013

Last week the market rallied on decent earnings news. More than 60% of the companies that have reported have exceeded profit estimates. However, only 40% have exceeded revenue estimates. It is important to remember that estimates have been lowered and “beats” should be expected. Year-over-year comps paint a very sluggish picture.

In a world with miniscule bond yields, stocks are attractively valued at a forward P/E of 15. The dividend yield on the S&P 500 is greater than the yield on 10-year US Treasuries. Corporate revenues might be flat, but margins are healthy due to cost-cutting. Cash flows are at record levels and balance sheets have never been stronger. Asset Managers are looking for safety and liquidity. US equities are benefiting from stability and a lack of investment alternatives.

Earnings releases have overshadowed weak economic releases. Traders dismissed the dismal jobs number a month ago because of a soft patch in April 2012. All of the economic releases in April have disappointed and I believe this is more than a seasonal adjustment. If the news this week disappoints, profit taking will overpower buying.

Asset Managers won’t chase stocks near an all-time high. They will wait for evidence that an economic recovery is underway. They will also assess the impact of fiscal spending cuts. I believe the bid is much more passive than it was a month ago.

Without question, the market wants to push higher. However, bad news is been discounted and any surprise this week favors the downside.

Conditions in Europe are so dire that the ECB will cut rates. A quarter-point is expected and I don’t believe they can reduce by a half-point. That would result in negative interest rates. This move is already expected and I don’t believe it will result in a rally. However, if the ECB does not cut, European stocks will decline.

GE and IBM both cited deteriorating conditions in Europe. This will likely be the second quarter of negative growth in the EU. New car sales hit a 20-year low last month and Spain’s unemployment rate is 27%. These are just a few pieces of information to keep in mind.

Italy elected a new Prime Minister and that will calm nerves. PIIGS interest rates declined on the news. Credit concerns are low, but they have flared up during the summer each of the last two years.

Growth in China is starting to slow. All of their releases in the last month missed. Government officials are satisfied current growth levels and they do not plan to stimulate.

I hope I am completely wrong and the releases are “good enough” to spark a breakout. I will keep my powder dry and if the news is good I will buy the breakout with confidence.

The bearish evidence is mounting and I don’t believe I am wrong. There have been many data points since the last jobs report that confirm the slowdown.

The markets are closed in China and Japan today so the volume is light. The good news in Italy sparked a rally and end-of-month fund buying is pushing the market higher today.

Wednesday will be critical. Official PMI’s will be released along with ADP and ISM manufacturing. Consensus estimates for ADP are 155,000. It came in at 158,000 last month and the number below 130,000 would be problematic.

Overnight risk is greater than the reward. I will day trade and keep my powder dry. If you are a swing trader, take some profits or at least buy some puts as a hedge.

My bias is neutral. Strong bullish trends die hard. In order for me to get bearish, I need to see late day selling, follow-through and technical damage. We are not there yet and it is foolish to pick tops.
The news is only a few days away and we won’t have to wait long to see how this plays out.

Be prudent.
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