Market Will Take A Breather Ahead of Spain’s Auction. Watch Cyclicals Thurs – We Need Them

April 18, 2012

Last week, stocks sold off on European credit concerns and traders reduced risk ahead of Spain’s bond auctions. This one dark cloud rained on the market until yesterday.

Spain’s bill auction was not disastrous and a relief rally pushed the SPY back above critical support at $138. As I mentioned Monday, these short-term maturities typically attract investors. Economic conditions in the US and China have been improving. Earnings releases have been decent and central banks around the world are easing. The market should be able to look past these Euro bond auctions.

Tomorrow, Spain will hold a longer-term bond auction and the results will not be as good. This will keep a lid on the market today.

The economic releases tomorrow include initial claims, the Philly Fed, housing starts and LEI. Empire Manufacturing declined to a 5-month low and the Philly Fed could be soft. The bigger number will be initial jobless claims.

The Unemployment Report missed estimates 2 weeks ago and that sparked a selloff. I believe that number will be revised higher. It was contrary to the ADP report and the four-week moving average for initial jobless claims. I consider both of those releases to be more accurate and current. Last week, initial claims jumped higher. I believe it was due to the Easter holiday and initial claims should decline tomorrow. That will be positive for the market.

Financial stocks and tech stocks have dominated the earnings scene this week. Banks have run up 24% this year and they are running out of gas. Financials have not rallied after posting earnings.Tech stocks have also rolled over and Google, Intel and IBM have all traded lower after the release. After the close, FFIV, EBAY, QCOM and VMW will release. The results will be good but the reaction will be muted. This means the market will have to find leadership elsewhere.

As I’ve been saying for the last week, I believe cyclicals are going to catch a bid. BHP posted its numbers and commodity stocks are moving higher this morning. Tomorrow, DuPont, Nucor and Union Pacific will post earnings. We need to see a positive reaction.

Cyclical stocks have not participated in the rally. This is taking a psychological toll on the market because investors still don’t believe that the economic rebound in the US and China is sustainable. The market will not be able to advance without these stocks.

At any moment, credit concerns in Europe can flare up. I don’t believe it will be an issue in April. The ECB can quietly support Spain’s bond auction tomorrow and a small bid will go a long way. This week the IMF secured $60 billion from Japan and that will put pressure on the US and China to contribute. Furthermore, they gave Italy a vote of confidence when they said government austerity measures don’t have to be scrutinized at this time.

The price action the last two weeks has been “toppy”. After a nice run yesterday, stocks should take a breather today. Traders won’t stick their necks out ahead of Spain’s bond auction and option expiration should create a choppy environment.

I have been selling out of the money put credit spreads and those positions did very well yesterday. I also bought stocks early in the day and rode the move higher. I sold those positions yesterday and I locked in profits. I am distancing myself from the action and I am limiting my overnight risk exposure.

If the market dips today, I will sell out of the money put credit spreads on cyclical stocks. We could see a little weakness on the open tomorrow, but stocks should be able to recover. Keep an eye on DD, NUE and UNP. If they hold their ground or move higher, this rally still has some upside. If they can get off the deck, the market will make a lower high and support at SPY 138 will be breached.
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