A week ago, I said that the market would drift lower this week and it would catch a bid into next week. The rally Monday was unexpected and I mentioned that the news did not justify the move. In the last few days those gains have evaporated and we still have a little weakness to work off.
This morning, GDP was unchanged at 3%. Some analysts were expecting it to rise and the news was slightly negative. Initial jobless claims dropped by 5,000 and that was a strong number. We have been in a news vacuum the last two weeks and that is about to change.
Spain will release its 2012 budget tomorrow and that has some traders nervous. I believe they will overpromise and the market will be satisfied with their austerity plans. Unfortunately, they won’t hit their projections.
The credit crisis in Portugal will soon be on the front burner (summer) and the market will have to deal with a new bailout. Italy’s Prime Minister said that he will step down if he takes too much heat from unions. He’s trying to do what is best for the country and he doesn’t want to fight constant battles. Italy held an overnight auction and the bid to cover was good.
Economic releases in Europe have been soft. Monday the official PMI’s will be released for Europe and China. These numbers should be consistent with the flash readings last week and they could spark a little selling Monday.
Traders are worried that China’s economy is slowing and the PBOC is not acting fast enough. Most analysts are expecting a reduction in bank reserve requirements in the next week or two. When this happens, it will restore confidence. China’s stock market started the year off strong and all the gains have been given back.
Economic conditions in the US have been solid. Construction workers are back on the job much earlier than normal due to warm weather. Construction spending (residential and nonresidential) is on the rise and home builders (LEN and TOL) are reporting strong sales. Banks are foreclosing and that will reduce inventory. Homebuilding is critical to an economic recovery. From 2001 through 2005, 50% of our job growth came from the housing industry.
Bank foreclosures have another benefit. They are reducing toxic assets. Financial institutions have been able to borrow money from the Fed at historic lows and they are lending at higher rates. The spread is fat and they have been able to make enough money so that they can shoulder real estate losses. Last week’s stress test revealed that 15 out of 19 banks could withstand and economic depression.
Our banks haven’t been this strong in decades. The flipside is true in Europe. Those banks have not taken write-downs and they are straddled with toxic sovereign debt. If Basel III were enacted, 23 out of 28 banks would fail.
Eurocrats are meeting to discuss a bigger “firewall” to prevent contagion. In essence, they will add a measly €200 billion to their slush fund. The EU is fragmented and it will only act when pushed to the very edge. European credit concerns will flare up this summer.
Our stock market and economy are on strong footing. Job growth is the key to a sustained economic recovery and the employment releases next week will be bullish. Initial jobless claims have been declining consistently over the last two months and that bodes well for next week’s number.
I believe we will see weakness on Monday after the official PMI’s. That will set up an excellent buying opportunity. On Wednesday, the ADP report will show strong private sector job growth and the market will rally into Thursday’s close (Unemployment Report Friday – Market Closed). Traders will not want to get caught short during this release.
When the market reopens the following week, Q1 earnings season will be on our doorstep. Stocks have rallied into earnings season each quarter for more than two years. Financials have been leading the rally and Goldman Sachs/Morgan Stanley post early. Trading profits will be up and we saw strong results from Jefferies two weeks ago.
I know that the price action yesterday felt pretty bearish. The volume is light and the decline was more of a buying boycott, not bona fide selling. The SPY will find support at 138.
Interest rates are low, corporate profits are growing, stock valuations are attractive (forward P/E of 14), there have been very few earnings warnings, job growth has been consistent and European credit concerns have been pacified.
This rally still has a few more runs left in it. I am long calls and I know that I will have to take a little heat over the next few days. I will be adding to positions on market support and I believe Monday will present an excellent buying opportunity. When I am done adding to my positions, I will have two thirds of my normal risk exposure into earnings season. I am not “all in” because I feel that from SPY 138 we are 8 points from a short term top. That still gives us plenty of room to make money.