Wait For Clarity Next Week. ECB Statements Will Set the Tone – Draghi Needs To Deliver

August 30, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Today’s comments were posted before the open. Normal trading activity will resume next week. Traders have been waiting for clarity and major events lie ahead.

Domestic economic releases have been decent. Yesterday, Q2 GDP came in slightly better than expected and the Beige Book showed gradual improvement nationwide. Initial jobless claims have been steady (374,000 today) and I believe ADP and the Unemployment Report will be in line next week. ISM manufacturing and ISM services have been hovering around 50. These are big releases, but I don’t believe they will have a major impact on trading.

China’s economic activity is contracting. Raw material inventories (coal, iron ore and cotton) are piling up. Iron ore producers and steel manufacturers predict a sustained decline in Asia. This has been the economic growth engine for the world. It has helped the US recover from the financial crisis and the situation in Europe would be much worse without this economic activity.

China’s interest rates are still fairly high and rate cuts do have an impact. The PBOC has been progressive and we should see another round of easing in the next few weeks. Sustained periods of hyper-growth lead to excess capacity. Consequently, the economic contraction on the back side tends to be severe. Traders are starting to wonder if the PBOC can prevent a hard landing.

China and Europe will release official PMI’s on Monday. The flash numbers were weak and this news could weigh on the market. Traders will give China a “free pass” for a couple of months as long as the PBOC is easing. If conditions continue to deteriorate the selling pressure will build. China’s market is making four year lows.

Next week, the ECB’s statements will be scrutinized. Draghi is attending the European banking union early in the week. I believe he will save major announcements for 9/6. The expectations are high. Traders want details. The ECB plans to keep short-term sovereign interest rates low and it is forging the model for a centralized European banking system. The market is expecting the ECB to stay ahead of the curve and it needs to deliver.

Here’s how I see things playing out in the next couple of weeks. Bernanke won’t move up the timeline for QE3 in Jackson Hole tomorrow and the market won’t like it. However, with “ECB Speak” next week the selling will be minimal. Traders don’t want to get short ahead of major events when the market is near a 4-year high. The PMI’s will be weak and traders will be expecting action from the PBOC. This sets up a very fragile situation.

As long as the ECB is making progress, even if it’s below expectations, the market will give it a few more weeks to get its act together. Patience will run thin and interest rates start to climb. Auctions in Italy went well overnight and Spain has an auction next week.

This market rally could last for another week or two, but we are living on borrowed time. In a few weeks it will be apparent that the EU still has major obstacles. Member nations won’t readily give up control of their national banks. The situation in Greece is deteriorating and it’s just a matter of time until they default.

Conditions in China will continue to deteriorate even after the PBOC eases. This will weigh on global economies.

The US and Japan both face fiscal cliffs. Some analysts believe that GDP in 2013 could decline by as much as 5% if all of the mandatory spending cuts are made.

These issues will take time to play out and there are many land mines ahead. I believe we will be able to get past next week, but the probability for a swift decline increases daily. I will wait to see how the news plays out and I am ready to buy puts on a breakdown below SPY $140.

The good news is that we will have clarity next week and activity levels will improve. I will evaluate the news and trade accordingly.

The market is pulling back a little this morning. I would not read too much into the move. In a light volume environment, we can expect choppy price action. Lay low for the next few days and wait for higher probability trading opportunities next week.

I will not be publishing market comments Friday. Have a safe and happy holiday.
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