Major Support Broken. One More Strong Push Lower. Wait For A Capitulation Low.

June 4, 2012
Author: Peter Stolcers, Founder of OneOption

Last week, the market tumbled below major support and it breached the 200-day moving average. Global economic conditions are deteriorating and credit concerns in Europe are escalating. The official PMIs were released last Thursday and Europe, China and the US all missed expectations. Germany has been an economic cornerstone for Europe and its activity faltered. For many months, investors have been hoping that strength in China will offset weakness in Europe. China’s economic growth is slowing and now analysts are lowering global GDP forecasts for 2012. China plans to launch a fiscal spending program. There were high hopes that a massive infrastructure build out would stimulate the economy. Last week, the media in China downplayed the magnitude of the program. Domestic economic releases have also been soft. GDP, durable goods orders, ISM manufacturing, ADP, initial claims, pending home sales and the Unemployment Report were weaker than expected. This news will revive QE3 hopes, but conditions are not dire enough to warrant swift action. Furthermore, the Fed's recent attempts have not produced results - they are “out of bullets”. The EU is fragmented and officials won't act until they are faced with an emergency. Spain needs a bailout (i.e. Ireland, Greece and Spain), but they don't want to give up fiscal control. That would mean they have to adhere to agreed upon fiscal policies. Instead, Spain wants bailout money for its banks. Last week, the ECB shot down its proposal to recapitalize banks and this negotiation could take time. Rumors circulated last week that the IMF would bailout Spanish banks. That will never happen unless the ECB takes a lead role. Italy is also facing political uncertainty. Their Prime Minister (Monti) is a technocrat. He is an economist, not a politician and he was elected to do what is fiscally best for the country. His popularity is dropping in the polls and this could force an election this fall. Speaking of elections, Greece will vote in two weeks. Pro-bailout candidates have a slim edge in the polls. If they win, we will muddle along on the current path. If they lose, the market will tank and Greece will default. Asset Managers (and CEOs) will not invest under these conditions. The EU is once again talking about fiscal unity. This issue has been dead for six months and they were supposed to draft a plan, approve it and amend the EU treaty by March 2012. That deadline passed and no progress has been made. Even if a concerted effort started today, it would take more than a year to draft a "meaningful" plan. This week we will get ISM services, the Beige Book, initial claims and trade balance. These numbers do not carry enough weight to stop this selloff. As I mentioned last week, Asset Managers will pull bids. They will wait for clarity and they will gauge the selling pressure. This means we are likely to hit an "air pocket". Panic selling will produce a deep intraday trough. We need to see a reversal from that low before we take profits on short positions. Once prices stabilize at that level, I will consider selling out of the money put credit spreads. If Greece elects a pro-bailout candidate and Spanish banks received aid from the ECB/IMF, we could get a nice relief rally. Stock valuations are attractive and the tech guidance (Dell, Hewlett-Packard, Cisco and Network Appliance) has been soft but not dire. I am long puts and I will hold them until I see a deep decline and a reversal. The first step is to take profits on bearish positions. If support holds for a day or two, I will sell out of the money put credit spreads. Option premiums are rich and we will be well rewarded for this strategy. I am not looking for a massive rebound, just a nice 5% bounce. Eurocrats will take vacations and credit concerns will flare up again in July/August. If you are anxious to lock in profits on short positions, use a close above the 200-day moving average as your guide. I still believe we will see one more strong push lower so I want to hang onto my short positions as long as possible. The price action today looks very choppy and traders are digesting the move from Friday. Late day selling is possible and I believed bargain hunters will wait for better levels. Try to hold onto bearish positions. . . image

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