Spain’s Debt Auction Not Horrible and IMF Gets $60B. Market Rally Needs Cyclical Stocks

April 17, 2012

Yesterday, the market was flat. Traders held their breath before a Spanish debt auction. They remembered the disastrous results from two weeks ago and they were not going to get caught off-guard. I mentioned yesterday that auctions on the short end of the yield curve have gone fairly well and that would set us up for a relief rally this morning.

Spain auctioned 12-month and 18-month bills and the bid to cover was better than expected. The market was bracing itself for a worst-case scenario and the auction was not disastrous. The Bank of Spain said that the country is in a recession and the 2012 outlook is bleak. Spain’s unemployment rate is 24%.

The default risk inside of 18 months is fairly minimal and banks will sponsor these auctions. This was a small €3 billion offering and even a small bid from the ECB would go a long way. The bigger auction will come this Thursday when longer-term bonds are sold.

The IMF said that it no longer has to monitor Italy’s austerity actions. That is a vote of confidence and it will temporarily stabilize Italy’s interest rates. The IMF also got a $60 billion pledge from Japan and that will pressure the US and China to contribute. This dose of good news will keep a bid under the market for a couple of weeks.

After the close, IBM, Intel and Seagate will post results. IBM was downgraded a week ago and the stock pulled back. The results should be good and it might have a little upside. Last week two research firms reported better-than-expected PC sales forecasts and that bodes well for Intel. However, SanDisk says that handset sales could be soft and that will offset PC sales. Seagate will post excellent results, but the guidance could disappoint. Hard drive prices are coming down and that will squeeze profit margins.

Tech stocks have been relatively weak. Google declined after posting earnings and Apple has been down 4 consecutive days. Stocks with the biggest gains are vulnerable to profit taking. The rotation out of the leaders and into the laggards would be positive. This market rally has not been broad-based.

The earnings news this week is dominated by financial stocks. J.P. Morgan and Wells Fargo declined after the release and these are two of the strongest banks. The whole sector will be reviewed by Moody’s and we are likely to see downgrades. The news this morning (Spain’s auction and IMF funding) has relieved credit concerns and bank stocks are up slightly. After a 24% rally this year, I believe the sector is vulnerable to profit taking. GS, USB, STT and NTRS are barely up after posting results this morning.

China’s economic activity is on the mend and recent releases (GDP, retail sales, IP, PMI and trade balance) have been positive. This should spark interest in cyclicals, commodity stocks and transportation. If these stocks can’t get off the deck, the market won’t get close to challenging the highs from two weeks ago.

The major economic releases this week will hit Thursday and they include initial claims, the Philly Fed, LEI and housing starts. After a wimpy Unemployment Report, traders will be keeping a close eye on jobless claims. The spike last week could have been holiday related and the market gave the number a “free pass”. A second consecutive rise in unemployment applications would weigh on the market.

The SPY has been waffling around the critical $138 level. Until the market makes a sustained move in one direction or the other, it is wise to distance yourself from the action. I am selling out of the money put credit spreads. I believe earnings will be good enough to avoid a major market decline and economic strength in the US and China should offset credit concerns in Europe.

I am also looking for earnings plays after the number. In particular, I want to see a gap higher after a period of consolidation on heavy volume. I am day trading these opportunities and I want to keep my overnight exposure to a minimum. Use the Live Update table as your guide. The earnings release dates are listed.

The rally this morning is pushing stocks back to the SPY $138 level. We will need a positive reaction to IBM/INTC/STX for the rally to continue tomorrow. Tech has been feeling heavy and I don’t know that we will get much of a rally.

Spain’s bond auction Thursday will keep this relief rally in check Wednesday. A fair bond auction Thursday and a decent reaction to DD, FCX, NUE and UNP would set us up for a nice rally above SPY $138.

Choppy price action around a pivotal price level, option expiration, earnings and a Euro bond auction make this market tough to predict, but I will give it a shot. I believe the market will get back above SPY $138 today and it will grind higher. Optimism about earnings after the close will be the driver. Tomorrow the market will inch higher but the gains will be small ahead of Spain’s auction. The auction will not be as good as the bill auction, but the US economic news will offset selling any selling pressure. Cyclicals will start to catch a bid and stocks will inch higher as earnings season kicks into high gear.
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