Yesterday, the market took a little bit of a breather. China’s flash PMI came in light and initial jobless claims were a little higher than expected. Stocks have been bumping up against major resistance and this dip was fairly predictable.
Not much has changed from a macro standpoint. Earnings season has almost ended and the economic releases are very light next week. European credit concerns have temporarily subsided and the market should be able to work through this soft patch.
The Republican National Convention starts Monday and that could provide a positive boost for the market. Q2 GDP will be released on Wednesday and Ben Bernanke will speak in Jackson Hole towards the end of the week. The news will be very light heading into a major holiday and trading volumes will drop. Activity levels have not been this low since 2007.
There is a very low-level of conviction and risk is elevated. Sentiment can change quickly and there are storm clouds on the horizon.
China has been a global growth engine and there are signs of a sustained economic decline. One of Brazil’s largest iron ore miners said that China’s growth boom is over. That sentiment was reiterated this week by Australia’s Resource Minister. These two sources have their finger on China’s economic pulse and if these forecasts are accurate, global economic activity will contract.
European credit conditions are always fragile and the market will be evaluating the EU in coming weeks. Traders want to see a central bank blueprint from Eurocrats and they want the ECB to stay ahead of the curve. Disappointment at this stage would result in higher PIIGS interest rates and the firepower of the EFSF would be tested immediately. We are in the early stages of the ECB’s plan to defend short-term interest rates and I believe they will keep interest rates stable while all of this gets ironed out.
The next market decline might not revolve around EU credit concerns. A global economic decline could pressure stocks. The US is up against a fiscal cliff the same is true in Japan (third largest economy in the world). These spending cuts will result in economic contraction.
I don’t believe these longer-term factors will be an issue next week. Stocks have a tendency to rally into major holidays. If the market pushes higher, bullish speculators will be lured in. “Fed Speak” should be positive and Draghi (ECB President) will also make statements next week.
Once this last push higher exhaust itself, we could be due for a swift pullback. That move will flush out bullish speculators.
Conditions are very tenuous and I urge you to keep your size small. The market could swing either way and it doesn’t make sense to risk hard-earned money. We will have much more clarity in a couple of weeks and the probability of success will increase.
To keep myself busy, I am day trading stocks from the long side. I am looking for breakouts after a period of consolidation and I’m focusing on stocks that are in an uptrend. Once the intraday momentum from these breakouts stalls, I take profits. I do not have overnight exposure.
Option implied volatilities are near historic lows and it does not make sense to sell premium. You are not properly rewarded for the risks you’re taking and the “juice” has already been sucked out.
This is a time to lay low. Volumes are very light and you can’t read too much into a move in either direction. I am favoring the upside next week but I’m keeping my positions small and I am maintaining tight stops.
Look for a positive bias next week and support at SPY $140. The further we get into September, the greater the probability for a pullback.