Last week, the market fell through major support levels. It breached horizontal support at SPY $136, the 100-day moving average ($134.70) and psychological support at $130. In a very bearish manner, it opened on its highs and closed on its lows each day.
Not much has changed over the weekend. I mentioned that I was selling out of some of my puts last Friday. This morning, I bailed on the rest of my short positions. I’ve made great money and I believe stocks will find support this week.
There wasn’t much news over the weekend. The G8 accomplished nothing and there were rumblings that the EU might establish a bank deposit program similar to FDIC. Pro-bailout politicians in Greece are gaining traction in polls and that has relieved some of the selling pressure.
The market has declined the last two years in May and both times, the selloff took a breather the week before Memorial Day. Stocks are oversold and trading volumes will decline. I believe we could see a small relief rally and I suggest exiting put positions today.
I do not advise going long. The rally this week will be nothing more than short covering. The problems in Europe run deep and Greece poses a serious threat.
Economic conditions in China are not strong enough to offset weakness in Europe. Recent releases (trade balance, factory orders and retail sales) fell short of expectations. Furthermore, China’s power consumption in April declined relative to first quarter consumption, new bank loans in May decreased, property values declined 1.2% and the Financial Times reported that some Chinese commodity buyers are defaulting on purchase contracts. These are all bearish signs.
The major economic news this week will be the flash PMI’s. Weakness is expected in Europe and traders want to see strength in China. If we don’t get it, the market will decline.
I will be sitting on the sidelines. A relief rally will drain option premiums this week and implied volatilities will decline. That move will provide me with a better entry point for short positions next week.
If conditions in Greece don’t improve, the selling will resume after the holiday. Support at the 200-day moving average (SPY $128.40) will be tested. That level will attract some buying, but Asset Managers will not engage this market until the elections in Greece are final.
If leftists win elections and reject austerity agreements, Greece will default. I believe the ECB/IMF will be able to prevent contagion, but the market will pull back sharply if they default.
The rally this morning feels “fluffy”. The news did not justify the move and there wasn’t much volume during the rally. This is simply a round of short covering. I believe prices will retrace a little this afternoon, but we will finish on the plus side.
The price action will be very choppy and I suggest day trading this week. Take profits on your short positions and focus on intraday moves. The flash PMI’s will be benign and the market will be able to grind a little higher into the weekend.
Keep your risk exposure small and wait for clarity.