Risk Profile Has Changed. Exit Long Positions and Use SPY 138 As Your Guide

April 9, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

This morning, the market is reacting to Friday’s dismal Unemployment Report. Only 120,000 new jobs were created in March and that is 90,000 less than expected. The market was closed Friday and everyone is adjusting this morning.

Traders were not able to react to the number and they had to hedge by shorting the S&P 500 futures. I believe the 15 point decline is a bit over exaggerated, but we won’t know until the end of the day.

The SPY tested major support at 138 and it held this morning. That is the horizontal breakout from March and it is the uptrend line from November. If this level fails, the selling pressure will increase.

I am skeptical of Friday’s jobs number. Initial jobless claims have been declining for more than two months straight and they fell 5,000 last week. These statistics are gathered weekly from all of the states and the four-week moving average is an accurate indicator of job growth. Furthermore, ADP said that 210,000 new jobs were created in the private sector in March. They process payrolls for small and medium-size businesses and they have their finger on the pulse of the labor market.

A sloppy employment release could revive QE3 hopes. This is also called the “Bernanke Put” because it keeps a bid under the market. Personally, I hope that this notion does not gain traction. At some point, the economy has to recover on its own. The Fed is almost out of bullets and its actions have little impact.

Economic conditions in the US and China have been improving. China posted a better-than-expected PMI last week. It released its CPI over the weekend and it came in at 3.6%. That was a little hotter than expected, but still an excellent number (almost a 2-year low). Later this week China will release IP, GDP and its trade balance. Good numbers would support the market.

Domestic conditions are also decent. ISM services, ISM manufacturing and retail sales were strong last week. The economic calendar is fairly light this week and it includes the Beige Book, initial claims, CPI and consumer confidence. I am less concerned with economic conditions than I am with European interest rates.

Last Wednesday, Spain held a horrible bond auction and yields jumped. European stock markets declined 3% and that weighed on our market. Spain has a 23% unemployment rate and investors don’t believe that they will adhere to the 2012 budget that was released. Italian interest rates are also moving higher.

The ECB’s liquidity injections provided temporary relief the last few months. Eurocrats promised to forge fiscal policies by March and to include them in the EU treaty. They have not made any attempt to draft a plan in the last four months and the market has very little confidence.

Earnings season will start tomorrow. Alcoa will post its numbers and soft results are expected. China’s economy has been gradually improving and the guidance is more important than the actual number. It will set the tone for cyclical stocks.

On Thursday, Google will release after the close and Friday morning, JPM and WFC will release. There have not been many warnings outside of the tech sector and earnings should be decent. Handset manufacturers and hard drive makers have seen recent selling pressure. Wednesday evening, two research firms will release their forecasts on PC demand and that could impact the tech sector.

I don’t believe that one bad unemployment number can spoil this rally. Stocks typically perform well into earnings season and the selling pressure this week should be contained.

The wildcard in all of this is European interest rates. The “genie is out of the bottle” and yields could remain stable and then explode higher overnight. The trend has been set. Interest rates will move higher, it’s just a matter of how quickly.

The earnings rally will be very tenuous. Traders will always have one eye on PIIGS yields. At the first sign of trouble, they will pull the plug.

I am ready to exit one half of my long positions. First I want to see if the market can rebound. Support at SPY 138 is giving me time to evaluate the price action. If the market is able to recoup most of the losses I will hang on to the other half of my longs overnight. If we see a late round of selling and SPY 138 fails, I won’t mess around. I will pull the plug on all of my longs and go to the sidelines. I will establish my losses and re-evaluate.

Taking losses and admitting when you are wrong is critical to your long term success. I look back at my analysis the last few weeks and I can justify my bullish outlook. Unfortunately, I was thrown a curveball. Now I have to evaluate the new information and adjust.

If I go to cash, my bullish trades will be very short term in nature. I will monitor sector strength and day trade stocks that are at the top of the Live Update table. In 3 short days, the risk profile for the market has changed dramatically.

As you know from my commentary, I was looking for a rally for the next 2-3 weeks. Once that move ran its course, I felt that an excellent shorting opportunity would present itself. Now, that time line has been moved up.

Reduce risk and take losses on some of your longs. Use SPY 138 as your guide. I would not short this market until I see PIIGS yields consistently move higher. They were up marginally in Spain and Italy this morning.
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