Sign of Strength. Market Could Have Declined On FOMC and Initial Claims. Sell OTM Puts

April 26, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

The market started the week on a negative note and it probed for support Monday. Economic and political news out of Europe raised concerns and the SPY tested support at $136. Once that wave of selling subsided, stocks rebounded.

The biggest news of the week was “swept under the carpet”. The IMF secured $430 billion in new funds from G20 nations. This gives it more than $1 trillion in its coffers. That slush fund will temporarily restore confidence and the market will be able to focus on earnings and economic releases.

European economic conditions are slipping, but that weakness should be offset by strength in China. Domestic activity has been soft in the last two weeks, but growth is still intact.

This morning, initial jobless claims fell by 1,000. They remain elevated and this is concerning. The Unemployment Report will be released in a week and the recent uptick in initial claims is a red flag. Tomorrow, Q1 GDP will be released. Analysts are expecting a growth rate of 2.2% and the “whisper” is that we might exceed estimates.

Earnings have been strong this week and cyclical stocks are catching a bid. This is important because Asset Managers are starting to embrace an economic recovery. These stocks have lagged and they have room to run.

One third of the S&P 500 has reported and earnings are up 10% on average year-over-year. Stocks are trading at a forward P/E of 14 and they are relatively cheap.

Central banks around the world are easing. Australia is poised to cut rates by 25 basis points and last week India lowered interest rates by 50 basis points (the first time in four years). Inflation has dropped below 4% in China and the PBOC has hinted that it will lower bank reserve requirements. Easy money is good for equities.

Yesterday, the Fed released a statement. Its zero rate policy remains intact, but they did not suggest that QE3 was currently being considered. This could have resulted in a market decline, but it didn’t. The market could have also declined on the weak initial claims number, but it did not. This is a sign of strength.

If you look at a two year chart of the S&P 500, you can see strength in the fall of 2010 and late in 2011. The common theme was Europe. When credit crisis fears subside, the market is able to rally.

I believe the IMF funding will temporarily ease credit concerns. The “sell in May and go away” crowd was a little early and now they are getting squeezed. The SPY is back above $138. As long as the jobs reports next week (ADP, initial claims and Unemployment Report) are not disastrous, the market should be able to grind higher for a few weeks. I am not looking for a massive rally.

Interest rates in Europe have stabilized. However, a few weeks ago we saw that one bad bond auction in Spain can spark a selloff. I am expecting a tenuous rally filled with plenty of ups and downs.

I have been selling out of the money put credit spreads on cyclical stocks. I want to distance myself from the action until the market picks a direction. I am also using the Live Update Table to day trade. Earnings season is filled with sustained intraday moves after the releases. This “hit and run” strategy allows me to limit my overnight risk and the earnings release dates are listed right on the table.

As long as European credit concerns are contained, solid earnings should push the market higher. Deteriorating economic conditions in Europe, flat conditions in the US and growth in China should all be a “wash”. The strength of this rally will be determined by cyclical stocks and we need to see them move higher.

Keep an eye on European interest rates.

After a nice run yesterday, the market has fallen into a tight trading range today. It needs to consolidate gains. If the GDP exceeds 2.2% tomorrow, we could see a small rally into the weekend.
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