Exit Long Positions and Start Getting Short!!

July 20, 2012
Author: Peter Stolcers, Founder of OneOption

"If the market can't rally during the first two weeks of earnings season, we are in deep trouble." This was one of my quotes from earlier in the week and I stand by it. The strongest stocks announce early in the cycle and the tone is typically very bullish. European credit concerns had temporarily subsided and the economic releases were light this week. Stocks should have been able to push higher after good news from IBM, Intel, eBay, Google and Microsoft. The SPY broke through resistance at $136 and option expiration should have provided a positive influence as stocks made new relative highs. Today, we are seeing profit-taking and the market was not able to hold the breakout yesterday. This price action tells me that the selling pressure is strong. Next Tuesday, flash PMI's will be released. Bad news is expected, but this reminder of deteriorating economic conditions will weigh on the market. A week from today, preliminary Q2 GDP will be released. Analysts are scrambling to lower their estimates after a dismal round of economic releases. The consensus estimate has been lowered from 2% to 1.7%. This release could be the "final straw". The market is addicted to easy money and the Fed has been stubborn with QE3. That's because they know it won't stimulate economic activity. As soon as they fire "the final bullet", the market will be looking for its next "fix". Central banks around the world have been easing in the last two weeks (BOE, ECB, BOJ, PBOC, Brazil, Korea...). That action should have provided a backstop for the market and during the first two weeks of earnings season and the upward momentum should have been strong. Earnings have been better than feared. However, guidance has been very cautious. Even the strongest companies in the world are concerned. Out of the S&P 500 companies that have reported, two thirds have exceeded earnings estimates. Unfortunately, three quarters of those companies have missed revenue estimates. Cost-cutting is apparent and corporations will keep payrolls lean. That is bad for employment. Pre-announcement warnings in Q2 were much greater than they were in Q1. Analyst estimates for the S&P 500 have only been lowered .8%. I believe there is a lot of room for disappointment as earnings season unfolds. China's stock market made a fresh 3 1/2 year low this week. It rebounded slightly, but the world's cornerstone for economic growth is faltering. Credit conditions in Europe are a huge concern. The ECB fired its last bullet a week ago and interest rates are at 0%. After getting beat over the head each week for the last two years, traders are numb to headlines out of Europe. The stakes have never been higher and I sense complacency. Italy and Spain are 10 times the size of Greece. These economies account for 20% of the EU's GDP. Interest rates have spiked to the "point of no return" and the market does not seem concerned. Option implied volatilities (VIX) are near the level seen in August of 2007. I believe we are set up for a major decline. Cyclical stocks and retailers will be releasing results in the next few weeks. The economic news will be heavy and the market will decline. Easing by the Fed will temporarily help, but sellers will realize that QE3 won't matter. November elections and the "fiscal cliff" will make matters worse. I've been holding off on short positions as long as I can. Today's price action might be option expiration related and I don't want to get too aggressive. Some of my put credit spreads are expiring today and I made nice money on those trades. Today, I am buying VIXY/VXX calls in September and I am buying my put credit spreads in August back. Those positions also yielded a nice profit. I will also be buying a few bearish puts and on Monday. Start buying puts today. Know that we are early and that decent earnings next week could still produce a rally. If SPY $136 fails, you can get more aggressive. . . image

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