Central Banks Provide Tailwind. Market Will Grind Higher Next Week. No News – Light Trading

August 3, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

Yesterday, the market declined after the ECB’s statement. Draghi was long on ideas and short on details. Now that the dust has settled, we have a better idea of what he intends to do.

EU members are expected to control fiscal spending deficits. If they do, they can apply for a bailout from the EFSF. Provided that the austerity actions have been material, the ECB will step in and support short-term bond auctions to keep borrowing costs relatively low. On a temporary basis, the market seems satisfied with the plan.

European credit concerns are impacting global markets and corporate decisions. As soon as fear subsides, stocks rally. Central banks around the world are printing money and they are ready to ease. This is a very powerful backstop.

This morning, the Unemployment Report showed that 163,000 jobs were added in July. That is consistent with the ADP Report and it was much better than expected (100,000). Seasonal adjustments distort the number and I feel that jobs were slightly exaggerated. If the number had been weak, I don’t believe the market would have tanked on the news. That would have simply put more pressure on the Fed to launch QE3.

Corporate revenues missed expectations this earnings season and guidance was light. However, companies are lean and mean. They hit profit targets through cost-cutting and they won’t be caught off guard by a double dip recession. Valuations are attractive and the S&P 500 is trading at a forward P/E of 13. Interest rates are at historic lows and Asset Managers desperately want to buy equities.

It takes a long time for me to formulate my market opinion and I don’t often deviate from it. I was bearish two weeks ago and I covered on the reversal last week. My entry point was good and I did not sustain losses when I stopped out. That was the biggest position I’ve had all year. The rally is very suspicious. I avoided a land mine and I knew I had to tread cautiously.

This is a very difficult market to gauge because it trades off of EU/ECB statements. The statements often lack detail and you never know how the market will react. As I mentioned, there are times when it is wise to sit on the sidelines and observe. This was one of those weeks.

Even though the ECB has simply provided another Band-Aid, the market believes it will work. Countries that have structural deficits will not be able to lend on a long term basis and bond durations will collapse. All I care about is the next few weeks and given that time horizon, European credit concerns won’t be an issue.

The news is extremely light next week and traders traditionally take time off before the kids go back to school. That is exactly what I plan to do.

Earnings season is winding down and the economic releases next week are very sparse. Interest rates in Spain and Italy have stabilized and Eurocrats will go on vacation. At least this year, the house of cards is not collapsing when they decide to take time off. If we do get a dose of bad economic news, central banks will stand ready to ease.

It’s never wise to short a quiet market. I believe stocks will grind higher next week in lackluster trading. There is a good chance that SPY $142 will be tested.

Since I’m taking time off, I am keeping my positions very small. Option premiums are near pre-crash lows and you are not properly rewarded for selling put credit spreads. I was able to sell some yesterday when the market broke below SPY $136. Those gains are offsetting my VXX call losses. Today, I will buy a few in the money calls on very strong stocks that are breaking through resistance. Some cyclical stocks also look attractive. I will have a GTC stop to get out of the positions if the SPY closes below $138.

The dark clouds have temporarily parted. Look for bullish price action the next few weeks.

I will publish my next daily market comments on Monday August 13th. If my forecast is right, the news will be light and it won’t take me long to get caught up. My battery will be charged and we will be ready for action this fall.
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