This Could Be the Last Soft Patch Before Earnings Season. Add To Call Positions Next Week

March 19, 2013
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Yesterday the market stumbled on minor credit concerns. Cyprus needs a bailout and individual bank account holders will be taxed on deposits. Bigger accounts will pay a higher percentage. In the grand scheme of things, we are talking about €10 billion. This will be nothing more than a blip on the radar in a few weeks.

Portugal, Ireland and Spain are much more important. Conditions in these three countries continue to improve and bond yields are stable. European credit concerns will not spoil this rally and they will not be an issue in the near-term.

FedEx will post earnings tomorrow. Domestic transportation will be relatively flat and fuel charges will bite into profits. Guidance is the bigger concern. FedEx is considered an economic barometer. Transportation in the US/Asia will be good and Europe will lag.

This same scenario will play out when flash PMI’s are released Thursday. China is the biggest wildcard. Recent tightening by the PBOC has resulted in a soft patch. Traders won’t be alarmed, but they won’t like the news. Stocks could drift lower after the releases. Once the dust settles, reality will sink in and investors will be satisfied with an 8% growth rate in China.

It is tough to predict every wiggle and jiggle in the market. All I can tell you is that all of the puzzle pieces are in place for rally. With each passing day the bid will strengthen. We are getting closer and closer to earnings season (April 8th).

Mutual funds have underperformed the market and the first quarter is about to end. We will see “window dressing” next week and I believe some Fund Managers will chase performance. The longer we go without a pullback, the more nervous Asset Managers will become. They have all been looking for a 5% pullback and they are not going to get one.

As economic conditions improve, analysts will raise earnings estimates. I believe the S&P 500 will make a new all-time high in April.

The FOMC will release economic projections tomorrow. We want a Goldilocks scenario – not too hot and not too cold. Current economic growth will face a stiff headwind as federal spending cuts kick in. This should result in a nice gradual recovery. QE will continue and the Fed will maintain a huge balance sheet for a long time. This news is priced in and I don’t believe the market will rally on the release.

Light volume rallies typically result in a round of profit taking. This pullback will run its course in the next few days and support at SPY 153 should hold. That is the breakout from February.

Use this time to evaluate your current holdings. Stocks that are resilient have a good chance of rallying when the market regains its footing. On the other hand, stocks that easily shed recent gains could be problematic. They might be out of gas and I suggest rotating out of them. Wait for the market to find support and scale into stronger stocks.

We are almost through this period of consolidation. The market has all of the ammo it needs and enough time has passed for the bid to strengthen. I will be buying calls this Friday and I will add next week. I plan to take my exposure from 40% to 65%. Purchase May calls. They span earnings season and they will hold their value much better than April options.

The soft patch this week could be the last one we see before earnings season. Be prudent and buy calls on support next week.
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