Yesterday, the market tested support at SPY 138 and it held. That level represents the horizontal breakout in March and the uptrend line from November. It has breached this morning and the selling pressure will increase.
After the close, earnings season will kick off. Alcoa has been soft and the expectations are fairly low. China’s economy is starting to rebound and that could provide optimistic guidance. That would put a bid under cyclical stocks. AA has not historically been a good indicator of market direction.
China’s trade balance was slightly better than expected. Imports were down and exports were better than expected. Inflation is relatively low (3.6%) and many analysts believe that the PBOC will reduce bank reserve requirements in the next week or two. On Thursday, they will release industrial production, GDP and retail sales. The consensus forecast for GDP is 8.4%. Even though their economic growth is slowing, 8.4% is robust.
Germany’s trade figures were better than expected and France’s industrial production was a little light. The focus in Europe is clearly on interest rates in Italy and Spain. Both were up 12 basis points overnight and they are steadily trending higher. European credit concerns are starting to flare up and this could be problematic.
The ECB’s liquidity injection temporarily pacified investors. European banks are up to their eyeballs in sovereign debt and they don’t want to buy more. These investments have resulted in huge losses and structural issues have not been addressed. Spain and Italy are cutting expenses and increasing taxes, but they have not reformed entitlement. Deficits will continue to grow.
Thursday is shaping up to be a big day for the market. A couple of research firms will release PC sale projections. Before the open, initial claims will be released and traders will be watching to see if they start increasing after a weak jobs report. After the close, Google will post earnings.
Overnight releases will also impact trading Friday morning. China will release its GDP, retail sales and industrial production. Italy will hold a bond auction and we will see if weak demand from last week’s auction and Spain spills over. Before the open, JPM and WFC will release earnings.
I must admit, I am starting to get “cold feet”. There have been a couple of tech stock warnings (handsets and flash memory) and a weak forecast Wednesday night would spell trouble. IBM was just downgraded last week. Any increase in initial claims would spook investors. Even if they only increase by a few thousand, traders will believe that job growth has stalled. Unemployment applications tend to decrease ahead of a holiday and the applications pick up afterwards.
China’s economic releases should be decent, but a dismal auction in Italy could destroy any optimism. Financial stocks have rebounded nicely and it’s possible that all of the good news for JPM and WFC is already priced in.
The market was not able to rebound yesterday and this morning critical support at SPY 138 has been breached. The decline has been relatively contained so far, but buyers are not stepping in. If we don’t get a rally after two hours of trading, the downside will be tested. If the selling momentum gains traction, we could be in for a few days of weakness.
Yesterday I sold out of half of my longs. This morning I am selling the rest. I am also buying a few SPY puts. I don’t like the increase in European yields and I don’t like the breakdown below SPY 138.
Exit long positions. This is not a bad time to be on the sidelines. Aggressive accounts can buy puts. Use a close above SPY 138 as a stop for short positions.