Market Needs To Consolidate Gains. It Will Inch Higher the Rest of the Week.

March 27, 2012

Yesterday, stocks started the week off on a very positive note. The momentum is so strong that one-day declines are immediately erased. Buyers stepped back in last Friday and that impetus spilled over to Monday. Comments from Chairman Bernanke fueled the rally yesterday.

Traders read between the lines during Fed speak and hopes of QE3 were renewed. Personally, I don’t believe further easing is required. Economic conditions are stable and improving. The Fed will be pressured into abandoning its zero rate policy well before 2014.

This morning, homebuilder Lennar posted great numbers. New home orders have been increasing for four straight quarters and they grew 33% from December through February. Economic activity is improving and warm weather will get construction workers back to work earlier than normal.

I am expecting a very strong Unemployment Report a week from Friday. As we get closer to the release, the bid to the market will strengthen and good news will be priced in. After the release, earnings season will be a week away. We have not had many warnings and investors will pile into the market now that it is making new multi-year highs.

Stocks still have 2-3 good weeks of strength ahead.

Durable goods orders will be released tomorrow and they won’t have much of a market impact because they are so volatile. The final revision for Q4 GDP will be released Thursday and the 3% number should hold. Initial jobless claims will continue to drift lower and that news is already expected.

There are not any major announcements the rest of the week and the trading activity will be lackluster. The EU will meet to discuss a €700 billion firewall on Friday. That level of funding would not stop contagion, but credit concerns are not much of an issue at this time. Spain will release its 2012 budget on Friday and that could attract attention.

Germany is already meeting with Spain to review its numbers and they want to make sure that it does not raise any red flags. The Prime Minister in Italy said that he will resign if unions feel that his measures are not in the best interest of the country. This is not a positive sign since the PM is pushing for austerity.

Interest rates in Italy and Spain have been creeping higher. The ECB said that they might not accept sovereign bonds as collateral if those countries have received bailout money. This would restrict the “carry trade” for European banks and PIIGS interest rates could start to rise. Massive structural issues still exist and they have not been addressed. This storm cloud will always be looming.

Economic conditions in China are soft but stable. Traders are waiting for signs strength and they want the PBOC to lower bank reserve requirements. When this happens it will spark another rally.

Economic conditions in the US are improving and optimism is running high. Asset Managers are shifting out of fixed income and into equities. There is $6 trillion of firepower sitting on the sidelines and this rotation still has room to run.

The Fed Chairman is speaking today but his statements should not generate much of a reaction. The market made a big run yesterday and it will consolidate those gains today. The downside will be tested early and the selling should be relatively contained.

The VIX has fallen to four year lows and that tells me that we are getting close to a correction. It can stay at this depressed level for quite a while before the market rolls over. Bullish sentiment needs to be kept in check and speculators will get flushed out in May.

We still have 2 to 3 weeks of positive price action. As the SPY reaches for 146, it will start to struggle. I am long calls and I’m letting my profits run. I don’t plan on hedging my positions. Instead, I will start scaling out of my calls. I’ve had a nice run and I don’t want to give my gains back. If we get one or two more days like yesterday, I will start taking profits.

Stay long and look for stocks that are breaking out after a period of consolidation. The price action will be lackluster today and we might inch higher throughout the week. The next decent rally will come next Tuesday or Wednesday.
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