The Strongest Companies Release Early In the Earnings Cycle. Look For A Rally This Week.

July 16, 2012

Last week, the market pulled back ahead of Chinese economic news. Activity in China has been decelerating and worst-case scenarios were priced in ahead of major economic releases. Industrial production, retail sales, fixed investments and Q2 GDP were in line and the S&P 500 staged at 22 point relief rally on Friday.

The news over the weekend has been relatively light and the focus is still on China. Finance Minister Wen said that economic conditions continue to slow, but they are starting to stabilize. The PBOC has been proactive. They have lowered interest rates twice in the last month and they lowered bank reserve requirements. Many analysts believe that we could see two more rate cuts and three more bank reserve requirement reductions this year. China’s CPI came in at 2.2% (the lowest in years) and inflation will not stand in the way of feature easing.

Interest rates in Spain and Italy are creeping higher today. Yields are close to all-time highs and conditions are tenuous. Spanish banks received aid a few weeks ago and Spain is asking for a sovereign bailout. Italy held a successful bond auction on Thursday and the ECB/BOE lowered interest rates. This backdrop should ease credit concerns for a couple of weeks.

This morning, retail sales declined .5%. This is the third straight month and consumers are cautious. Empire Manufacturing came in slightly better than expected. There are many minor economic releases this week, but they won’t stand in the way of an earnings rally.

J.P. Morgan and Wells Fargo both moved higher after posting earnings. This morning, Citigroup beat estimates even though revenues were soft. Banks and tech will dominate the earnings scene this week. The financial sector looks like it wants to move higher. Tech stocks have been down and Intel, IBM, Microsoft, Google, eBay and QUALCOMM should spark buying.

Shorts got a little too aggressive last week and I believe they will get squeezed this week. The SPY should be able to rally above resistance (100-day moving average) at $136. I don’t think it will get to $140. There are many storm clouds on the horizon and Asset Managers will take profits before it gets there.

I am looking for a nice little rally this week. My bearish outlook will keep me from getting too aggressive. I have been selling out of the money put credit spreads on companies that generate most of their revenues in North America. I don’t want any exposure to Europe or China. I might day trade from the long side and I might even buy a few calls. I will keep my risk exposure light.

My true focus is on the selloff I see coming in a few weeks. For now, I am biding my time and I am trying to stay out of trouble. I don’t want to be straddled with a bunch of long positions. When the selloff begins, I don’t want to waste time unwinding longs, I want to focus on getting short.

Look for the market to recover from early losses today. I believe we will see a nice rally this week and a breakout above SPY $136.
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