Buy Puts. The Overnight News Was Not That Good. Support Has Been Breached

May 15, 2012

Today’s comments were posted before the open.

Yesterday, the SPY breached the 100-day MA and it closed near the lows of the day. European credit concerns are weighing on the market and now that technical support has been broken, the selling pressure will increase.

Asset Managers will pull their bids until they have more clarity. This wave of selling will hit a couple of air pockets and eventually a capitulation low will establish support. It might be a few weeks before we see that pattern. In the meantime, nothing has changed overnight. The early rally is nothing more than a temporary bounce.

China’s foreign direct investment fell .7% in April and the street was looking for a 2.8% increase. Power demand grew by 3.7% year-over-year in April and that was weaker than the 6.8% growth in Q1. The economic releases last week (factory output, trade balance and retail sales) were light. Over the weekend the PBOC lowered bank reserve requirements and that news did not spark a rally because it was long overdue.

Europe posted flat GDP growth (0%) and that was better than expected. Germany was the big surprise. Its economy grew 1.7% and the street expected growth of .9%. The rest of Europe came in below estimates. This news sparked a small relief rally.

Greek politicians are scrambling to form a coalition to head off a leftist candidate who will reject austerity agreements with the troika. If they can’t form a party to run against him, they will lose and Greece will default. This news will play out in the next three weeks. Greece did make a €430 million bond payment and that is relieving a little selling pressure today.

Moody’s downgraded 26 Italian banks Monday night. This news was largely expected. Spain’s banks are grossly undercapitalized and their plan to form a “bad bank” did not impress investors. They will need upwards of €30 billion to shore up the problem. Interest rates in Spain are making new highs. This is a huge red flag.

Domestic economic releases have been mixed. I mentioned that manufacturing should be decent this week after a better-than-expected ISM manufacturing number two weeks ago. This morning, Empire Manufacturing came in above 17 and that exceeded estimates. Retail sales increased by .1% and that was a little light. Home Depot missed estimates and that could weigh on the sector. CPI was flat (lower energy prices tamed inflation).

The FOMC minutes will be released tomorrow. Last month, QE3 was not “on the table” and that will come out in the release. The market is addicted to easy money and the news could weigh on the market Wednesday afternoon.

Industrial production, housing starts, initial claims, the Philly Fed and LEI should all be market neutral. The biggest release will be initial claims. Traders will be watching for any uptick. It has come in at 365,000 the last two weeks.

European credit concerns are weighing on the market and the overnight news will not do anything to calm nerves. Greek politicians have not formed a coalition, Spanish banks are in dire need of capital, Italian banks were downgraded and most of Europe experienced economic contraction. A slightly better than expected GDP in Germany won’t compensate for the rest.

Furthermore, China’s growth has to offset weakness in Europe. Their economy is not rebounding to the extent that it needs to.

US economic activity is stable. The remaining releases this week will be market neutral. Asset Managers feel that the economic pendulum could swing either way and they are not aggressively buying stocks.

Technical support has been breached and that will result in another wave of selling. Option implied volatilities have broken out to new relative highs – fear has returned.

I’m mentioned yesterday that I was buying puts and that I expected late day selling. Bulls ran out of steam and the market closed on its lows. I will be buying more puts this morning. I will buy a few on the open and I won’t hesitate to add quickly. I will stop those positions out if the market closes above the 100-Day MA (SPY $135.19).

Look for this early rally to fail. The market should drift lower today.
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