Major Breakdown. Stay Short As Long As SPY Closes Below 138. Could Get Follow Thru Thurs.

April 11, 2012

Yesterday, the SPY broke major support at 138 and stocks closed on their low of the day. The breakout from March has failed and the uptrend line from November has been breached.

Monday’s decline tested the SPY 138 support level and the market was not able to bounce off of it. Traders were not going to buy under those conditions Tuesday and they pulled their bids. Asset Managers did the same so that they could gauge the selling pressure. Yesterday’s selloff came on light volume.

After the close, Alcoa posted better than expected results. They project 7% revenue growth in 2012 and they cited strength in China. The release was not overly optimistic, but commodity stocks have lagged during the recent market rally. This morning, the sector is moving higher.

In Europe, Italy auctioned short-term bills. These auctions tend to do well since they are inside of the three-year LTRO window. Yields on one-year bills rose to 2.84% (up from 1.4% a month ago). This was not particularly good, but it wasn’t disastrous either. European stock markets rallied on the news.

The bigger test will come tonight when Italy holds a longer-term bond auction. The demand will be light and we will see just how high rates move. Yields in Spain and Italy are steadily moving higher and credit concerns will be an issue.

Two research firms will release PC revenue forecasts this evening. This will impact tech stocks. Hewlett-Packard has been grinding higher and the expectations are favorable. VMWare said that it will meet or slightly beat estimates and the stack is down 2%. William Blair & Co. said that FFIV is pushing hard to close deals and it feels that it might be struggling to hit its number. The stock is down $6. The tech sector might struggle after recent warnings.

Tomorrow, initial claims will be released. Applicants postpone filing ahead of major holidays. They file after the holiday and we could see a small increase. After a weak Unemployment Report, traders could get spooked thinking that the jobs recovery is over.

This news could have a temporary affect, but it won’t topple the market for two reasons. First of all, I believe the Unemployment Report will be revised. It was not consistent with ADP and initial claims. Secondly, if employment conditions deteriorate, hopes of QE3 will be revived.

After the close on Thursday, Google will post its number. It will set the tone for the tech sector. Friday morning, JPM and WFC will release. Financial stocks have rallied substantially in the last quarter and the expectations are high. Many analysts believe that trading profits will be good. Consumer loans have also been increasing. The sector might have a little more upside, but I believe credit concerns in Europe and domestic banking regulations will keep a lid on the rally.

Tomorrow evening, China will release GDP, IP and retail sales. Strong reports would be “market friendly”. Economic conditions have been improving and the trade balance number was decent this week. Even if economic activity misses expectations, analysts are expecting the PBOC to lower bank reserve requirements. That should keep a bid under their market.

Pinning this market is like trying to nail Jell-O to the wall. Economic conditions should be decent and earnings should be good (there have not been many warnings). Stocks typically rally into the first two weeks of earnings season and the strongest companies release early in the cycle. European interest rates are the wild card. If they are stable, stocks will grind higher. If they spike, the market will tank as investors run for cover.

I sold my call positions early yesterday morning. The market did not bounce off of support and it was obvious that bears would test the downside. I bought puts at a good price and I am still in the black after this morning’s relief rally. If the SPY closes below 138, I will hold my put positions overnight. I believe the Italian bond auction and initial claims could weigh on the market. I do not have a large position.

If the market does rally above 138, I will exit my put positions and I will day trade stocks in strong sectors. I will focus on stocks that are at the top of the Live Update table. I do not want to hold overnight positions because of the recent volatility.

Here is what I do know. Fear is creeping back into the marketplace. Stocks have posted excellent gains this year and after a flat 2011, Asset Managers won’t mind locking in profits. Interest rates in Europe are marching higher and the EU hasn’t done a thing to address fiscal reform. The “genie is out of the bottle” and a market top has formed.

The next excellent trading opportunity will come on the short side in a few weeks.

As for the current bearish position, I am just looking for a little follow-through. Stocks have not been able to advance after the initial rally and that tells me we could drift lower this afternoon. The Italian auction was not that good and Alcoa’s guidance was not that strong. This was a major breakdown. Stick with the puts as long as the SPY closes below 138. Keep the position small. We are looking for follow through to yesterday’s breakdown. If we get a couple of down days I will take profits. Know that we are trading against seasonal strength. Mind your stops.
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