Economic Releases Were Weak. Stocks Will Retreat – Get Short

June 21, 2012

The market staged a relief rally this week and it hit resistance yesterday. I suspected that the overnight news would spark selling and stocks are quietly drifting lower.

Spain got its bank bailout two weeks ago. This was a progressive move on the part of the EU, but yields continued to climb. Spain held an auction overnight ($2.2B) and the results were mediocre. Today, EU banking officials will reveal the magnitude of the banking problem in Spain. It is likely that additional funds will be required.

Pro-bailout candidates won Greek elections by a narrow margin. The country is divided and future bailouts will be required as tax receipts plummet.

Next week, an EU summit will be held. Eurocrats will discuss grandiose ideas and nothing will be accomplished. Soon they will disappear on vacation and the market will get nervous. We’ve seen this pattern the last two years and the table is set for another round of disappointment.

The economic releases overnight were weak (China’s flash PMI, initial claims, and the Philly Fed). The FOMC statement did not include QE3, but Operation Twist was extended through 2012. Ben Bernanke described deteriorating economic conditions and investors are selling.

The economic calendar is fairly light next week (consumer confidence, durable goods, initial claims, GDP and Chicago PMI). These releases will have a negative bias, but the focus will be on the European summit.

As I mentioned yesterday, the market is due for a pullback. I don’t believe we will see a nasty round of selling. Earnings season is approaching and we could get a warning or two.

Eurocrats will “whisper sweet nothings” and the market will temporarily be satisfied. Stocks are attractively valued and they will move higher into earnings season (July 10th). The market also tends to rally into major holidays and the 4th of July is right around the corner.

Look for a pullback though next week. Once support is established, there will be an excellent opportunity to sell out of the money put credit spreads. That strategy will work well during the earnings rally and it will allow you to keep your distance. Towards the end of July, I believe we will be set for a sustained decline.

I exited all of my long positions before the FOMC yesterday and that turned out to be a wise move. I have been buying puts this morning and I’m glad I’ve been able to get in at a decent price. The SPY should be able to find support at $130. That is a horizontal support level and it is the 200-day moving average.

Stocks will drift lower and we could see selling into the bell.

Get short.
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