Buy Puts. The Market Will Test the 200-Day MA. That Level Could Fail Next Week.

May 30, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

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Yesterday, the market rallied on news events in Europe and China. The pro-bailout party in Greece (New Democracy) edged out a small lead in the polls and that calmed investors. China proposed a fiscal spending program that would focus on infrastructure and stimulate economic activity. Both these events sparked buying.

As I wrote in my comments last week, I have been anxious to get short. Yesterday I added to my put positions during the rally and I added again today. Asset Managers will not aggressively bid for stocks during times of uncertainty. They will step back and wait for clarity and signs of support. I believe the market will test the 200-day moving average and it could be breached.

The Greek polls have improved, but this is still a 50/50 proposition. We are two weeks away from the elections and there will not be any polls (inside of 2 weeks) to give us a sense of direction. Even if Greece elects a pro-bailout candidate, the problems will continue to fester.

Spain’s interest rates have broken out to new highs. Yesterday, I mentioned how dangerous this is and I included a chart. Spain wanted to exchange government bonds for equity in distressed banks. Under the plan, banks would pledge Spain’s bonds to the ECB and they would receive much-needed capital. Today, the ECB rejected this plan.

In my comments yesterday, I explained how this “backdoor” strategy went against comments made by the ECB a few months ago. This is an indirect purchase of Spanish debt and the ECB said that it does not want to participate in sovereign debt auctions. This news is weighing on European markets. Spain’s banking crisis could require more than €60 billion in aid.

Europe will officially post it PMI’s tomorrow. The flash numbers last week were dismal. Germany was of particular concern since its activity fell below expectations. It has been the cornerstone for European economic stability. Negative news is already priced in, but this will be a reminder that conditions are deteriorating.

China’s economy is stable and growth is inching higher (but still below expectations). The fiscal spending plan would have increased economic activity. Unfortunately, China’s media is downplaying the magnitude of the plan saying that it will not come close to the stimulus in 2008. Regardless, China’s growth is not robust enough to offset weakness in Europe. Power consumption is declining relative to Q1 and bank lending has decreased in May.

Corporations will not aggressively hire or reinvest in this environment. We have seen a decline in IT spending and Cisco, Dell and Network Appliance recently provided weak guidance. This news is weighing on the tech sector.

Initial jobless claims are hovering at 370,000. Job growth has stalled and I believe tomorrow’s ADP report will come in below estimates (160,000). If this happens, it will set a negative tone heading into Friday’s Unemployment Report.

In the last two years, the market has declined in May. Stocks bounced briefly ahead of Memorial Day and then the selling resumed. I believe that pattern will repeat itself.

The momentum points lower and I suggest adding to bearish positions. Greece is a crapshoot and Spanish yields have spiked to the “point of no return”. Eurocrats will soon go on vacation and investors will panic when no one is “minding the shop”.

When the market pulled back from its highs yesterday, I bought puts and I had a third of my normal position on by the close. I kick myself because I “jumped the gun” and I took a little heat late in the day. This morning, I’m glad I added to those positions. I am buying more puts this morning and I will have half of my normal position by the end of the day. I believe the market will drift lower this afternoon and tomorrow’s ADP report could spark another wave of selling.

At best, Asset Managers will nibble during deep intraday lows. They will passively bid for stocks at the 200-day moving average. If that level fails easily, they will step out of the way and we will hit an “air pocket”.

Get short.
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