Support At SPY $136 Failed. The 100-Day MA Will Be Tested This Week. SPY $134 Should Hold

May 8, 2012

Last week, the market pulled back on weak economic news in the US. The Unemployment Report, ADP and ISM services were weaker than expected. Elections in France favored socialist Hollande and that result was priced in.

Yesterday, the market rebounded from a deep overnight decline. Traders had second thoughts about the outcome in France and poll results in Greece showed that pro-bailout candidates declined in popularity. The Sunday night selloff was a warning sign.

The elections in France won’t have an immediate market impact. The new tax-and-spend policy will take months to implement. Austerity plans will be retracted. From my perspective, the longer-term impact will come from the lack of entitlement reform. Socialists will keep current policies in place and huge deficits will continue to build. France is not a current concern.

If a new ruling party wins elections in Greece, a default could be imminent. They will reverse austerity plans and in the process they will jeopardize IMF bailout money. This will take a few more weeks to play out.

Eurocrats have to be getting tired of this tiny member. I would not be surprised if behind the scenes they have a contingency plan to simply let Greece fail. If this were to happen, it would be bearish for the market on a short-term basis. On a longer-term basis, it might actually be positive. Greece is in such disarray that there is not a long-term solution.

The ECB has provided plenty of liquidity to Euro banks in the last 6 months and that should help them “shoulder” Greek loses.

Spain will reveal a “bad bank” plan this week. It wants to transfer toxic assets to a national balance sheet. It could simply nationalize some of the weaker banks. It will need to borrow money from the EFSF/IMF to accomplish this and analysts estimate it could require €20 billion. This should temporarily calm nerves.

This morning, FOSL said that European retail sales will decline and that will dramatically impact profits this quarter. That news has impacted other companies that generate revenues in Europe.

Wednesday, China will release its trade numbers. Economic growth has been steady and Q1 GDP grew 8.1%. Many analysts expected them to lower bank reserve requirements weeks ago and they are growing impatient. Inflation has dropped below 4% and China should take action in the next week or two. When this happens, it will spark a relief rally in cyclicals and commodities.

The news will be light this week. Earnings releases are tapering off and the major economic news is behind us. The market will trade off of last week’s information and it has a negative bias to it.

As I mentioned yesterday, the market has more work to do on the downside. The SPY easily traded through support at $136 today and it will test a major support level at $134 this week. I am expecting it to hold.

Spain’s “bad bank”, lower bank reserve requirements in China and hints of QE3 could all provide a bid. Earnings reports have been good and profits are up 10% year-over-year on average. Central banks have been easing and that is always good for equities. Last week’s initial claims declined and the warm weather employment distortion from March might have run its course.

It is tempting to “sell in May and go away”. That pattern has been very pronounced the last two years. Bearish speculators are piling in and I suspect they will have the door slammed on their fingers once support is established. The news is slightly negative, but it is not disastrous. The IMF’s $1 trillion slush fund will pacify credit concerns.

Yesterday I closed out two thirds of my put credit spread positions for a profit. I did not like the market decline Sunday night and I’m glad I reduced my risk. This morning, I bought back the remainder of my put credit spreads (breakeven) and I shorted stocks in the open. I will buy back my short stock positions late in the day.

Once support is established, I will sell out of the money put credit spreads in June. Option premiums are on the rise and I can distance myself from the action. I still like this as a core position. On a short-term basis I will day trade stocks. In this choppy, unpredictable market, this strategy has worked well.

Technical damage has been done and horizontal support at SPY $136 has been breached. The market will test the 100-day MA at SPY $134.60 this week. Major horizontal support lies at SPY $134. If that level is tested, I expected to hold. As long as European interest rates remain stable, that support level will represent an excellent buying opportunity.

I like staying short today. The market should be able to find support above the 100-Day MA, so I am not looking for an afternoon meltdown (30+ S&P points). If we close on the lows of the day, expect follow through selling tomorrow.

The first bounce off of support will squeeze the “sell in May” crowd and the reversal should produce a nice move.
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