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The market is trying to cope with deteriorating economic conditions and European credit concerns. GDP, durable goods, pending home sales, ADP, Challenger, Gray & Christmas and initial jobless claims all missed the mark. Spain had a “backdoor plan” to secure financing for its banks and it was shot down by the ECB. Yields are climbing and they have reached a “flashpoint”. The market is retreating and as I’ve been forecasting, the 200-day moving average will be tested.
This morning we got a fresh round of economic news. The official PMI’s in Europe and China missed expectations. Dismal results were expected in Europe, but China’s number was expected to come in around 51.7 (actual 50.4). For a couple of weeks I’ve been tracking power consumption and new bank loans. Both have decreased and I projected a weak number. The S&P 500 was down 15 points overnight. Domestic economic releases flamed the fire this morning.
Analysts were expecting 150,000 new jobs in May. Only 69,000 jobs were created and the S&P 500 dropped an additional 10 points on the news. Initial jobless claims have been creeping higher and ADP was a disappointment yesterday. The warning signs for a “bad number” were everywhere. After the open, ISM manufacturing was released and it also missed.
Greece will hold elections in two weeks (June 17) and pro-bailout candidates have a 2% lead in the polls. This margin of victory is paper thin and Asset Managers will wait on the sidelines until the actual results are known. Even if the pro-bailout party (New Democracy) wins, Greece will struggle with the current austerity plan.
Spain’s banks are in terrible shape. The ECB rejected their capitalization plan this week and the situation will escalate. Analysts believe that they will need at least €50 billion to stop the bleeding. Rumors circulated yesterday that the IMF would lend it the money and the market rallied on the news.
The IMF has $1 trillion in its coffers and it appreciates the magnitude of the situation. However, they will not be the lender of last resort. They want to see the EU/ECB take the lead role in any bailout proposal. When I saw the reversal yesterday I knew it would be short-lived.
Eurocrats take forever to make a decision and the situation will have to reach perilous levels before they act. This is not just my opinion, it is a behavioral pattern. Europe was on the brink of a financial collapse last November and the ECB launched its LTRO at the 12th hour – there are many other examples.
Stock valuations are extremely attractive and that is the one bright spot. Balance sheets are strong and payrolls are lean and mean. CEOs have also been managing inventories and they won’t be blindsided by this economic decline. They are holding off on capital expenditures and while that is prudent, it is adding to the problem. Cisco, Dell and Network Appliance all posted weak guidance and earnings estimates will be lowered for Q2 due to the lack of IT spending.
So here’s where we stand. Global economic conditions are contracting, European credit concerns are escalating and corporate guidance is weak. The market will test the 200-day moving average next week (if not today). Asset Managers will nibble at that level, but they will pull bids if they don’t believe it will hold. We could see a small bounce off of the 200-day moving average, but it will fail on the retest. The market will hit an “air pocket” and buyers will wait for a capitulation low.
I believe that the ECB/IMF will lend money to Spain. They need to act quickly or investors will lose confidence. Contagion must not spread. Spain is the “first big domino” and Europe needs to send a clear message that it will do whatever is necessary. I believe they will make an announcement in two weeks. As stock markets retreat, they will be pressured into action. If they wait for the election results in Greece, they are opening themselves up to a potential disaster (anti-bailout victory and an unresolved banking crisis in Spain). They need to act immediately.
This capitulation low will set up an excellent buying opportunity. There will be a heavy round of short covering and Asset Managers will bargain hunt. The magnitude of the bounce will be dependent on global economic conditions.
There are a few economic releases next week (ISM services, Beige Book, factory orders and initial claims), but they won’t spark enthusiasm. The warning signs are everywhere and it’s not “just Europe”.
I am long puts and I got short across all of my services last week and we added on Tuesday’s rally. The gamble is that the ECB/IMF won’t get their act together for at least a week. As they draft a bailout plan, the market will tumble.
If the 200-Day MA finds strong support (doubtful), I might cover some of my shorts. I am prepared to weather a small bounce. The retest could be nasty especially if it is accompanied by another weak economic release. Once we hit the “air pocket”, I will use trailing stops and I will watch for an intraday reversal off of a deep trough.
If you followed my advice, you are making some serious money today.
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