Bargain Hunting and Short Covering. News Is Not That Great. This Is A Technical Bounce

June 6, 2012
Author: Peter Stolcers, Founder of OneOption

Monday, stocks tested the downside after breaking below the 200-day moving average. Bargain hunters stepped in and the market finished off of its lows. Yesterday, an early rally held and a small round of short covering pushed the SPY above the 200-day MA. That momentum is continuing today. The biggest overnight catalyst is that Spain will get aid from the EFSF. It will use the money to purchase equity in failing banks. For the time being, this is simply speculation. The EU/ECB/IMF will forge a plan in coming weeks and the market is pricing that in. Spain wants the ECB to directly bail out its banks because it does not want to give up control of its fiscal spending. Germany opposes any direct bank bailouts and this negotiation could take time. Spain will hold a bond auction tomorrow. Given the tenuous environment, I believe the ECB will support the auction and it will ease nerves. Greek elections are not a huge issue because the market is pricing in a win by the New Democracy. This would mean that current austerity plans will continue and they will receive bail out money. Unfortunately, that aid won't cover its bills. Tax receipts are dropping dramatically and they will miss their budget by a wide margin. The relief rally will be temporary and Greece will be asking for more money. The ECB's statement this morning disappointed those who are looking for LTRO3 (not mentioned) The ECB will extend some of its liquidity operations and the comments were "dovish". Draghi said, "Economic growth in the euro area remains weak with heightened uncertainty weighing on confidence and sentiment giving rise to increased downside risk to the economic outlook". The economic news is rather light this week. ISM services came in slightly better than expected yesterday. Initial jobless claims will be important tomorrow. Traders will view any increase as negative. I believe the number will be flat and stocks will inch higher. When the market held early gains yesterday I got nervous. I told myself that I would exit bearish positions if we crossed back above the 200-day moving average. I sold all of my puts across all of my research reports, but I did not buy calls. The news did not justify the rally and I am still looking for a strong push lower. Spain has not secured financing and the negotiation could continue for weeks as conditions deteriorate. Pro-bailout candidates might win elections in Greece, but deficits continue to grow and the troika will continue to throw money into this black hole. Economic conditions in Europe are deteriorating and they are slipping in the US. This is a technical bounce. Once this rally stalls, Asset Managers will reduce risk (sell stock). That resistance will establish a "lower high" and I do not believe we will get back to SPY 134. The next wave of selling will result in another breakdown. It might take a couple of weeks before we see the next decline. Asset Managers and CEOs will not aggressively invest during times of uncertainty. Spain’s banking crisis will weigh on the market and Eurocrats will put pleasure (vacations) before work (credit solution). I am selling a few put credit spreads today. I want to take advantage of attractive stock valuations and rich implied volatilities. I don't believe we will see a big decline before June expiration. These positions will generate a little income while I wait for the next shorting opportunity. If the SPY closes below the 200-day moving average and will buy them back and I will buy puts. I'm glad I took profits yesterday and I am happy to be on the sidelines. Look for stocks that held support during the last few days of selling and are rallying today. I like commodity stocks, home builders and tech. I would not advise call buying. Option premiums are rich and you will need a sustained rebound to make money on that strategy. I don't think we will get that type of move because the macro backdrop is not good. Stocks will continue higher today and they should have a slightly bullish bias the rest of the week. We might have another 20 S&P points to the upside before we hit resistance. . image

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