Lack of Bad News and Momentum Is Pushing Stocks Higher. 2 Steps Forward – 1 Step Back

March 26, 2012
Author: Peter Stolcers, Founder of OneOption
Author
Pete

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Last week, the market hit a little bit of a soft patch while it was waiting for news. The PMI’s out of China and Europe were lighter than expected and Asset Managers pulled their bids. A buying boycott (not selling pressure) resulted in a small sell-off.

The decline only lasted a day and buyers stepped back in. Momentum is carrying stocks higher and we won’t have any major news releases to lean on this week.

Spain will release its 2012 budget on Friday and it will be scrutinized. Germany is sending a team to review the plan this week. Interest rates in Spain have been creeping higher and it is one of the weakest EU members.

Over the weekend, the ECB stated that it might reject certain sovereign bonds pledged by European banks. If the EU members (PIIGS) have received bailout money, the bonds may not be accepted as collateral. They are trying to minimize the “carry trade” now that conditions have stabilized. This is exactly why interest rates in Italy and Spain came down and it was the most effective part of the LTRO maneuver. I see this news as bearish.

This week, durable goods orders, initial claims and the final revision to Q4 GDP will be released. Durable goods orders are volatile and the number does not typically have a lasting market impact. Initial claims have been declining and warm weather should keep that trend intact as construction workers go back to work earlier than normal. GDP should come in as expected.

The official PMI’s for Europe and China will be released over the weekend. There should not be any surprises.

US economic releases have been solid and I am expecting the market bid to strengthen into the Unemployment Report in 10 days. Earnings season is a few weeks away and that will also attract buyers. The warnings so far have been minimal and the earnings releases last week (FedEx, Nike, ACN, COST and TIF) were good.

Bank stress tests are behind us and only 4 out of 19 banks did not pass. This does not mean they are weak; they simply might not withstand an economic depression. Financials have been moving higher and they are leading the rally.

Interest rates are creeping higher and this is a healthy sign. The market is pricing in sustained economic growth. Asset Managers are shifting out of fixed income and into equities. More than $6 trillion sits on the sidelines in treasuries and this rotation still has room to run as long as European credit concerns are contained.

I believe the market still has a few good weeks left in it. The gains will be hard-fought and for every two steps forward we will take one step backwards. You need to stay long or you will miss moves like the one this morning. All of the profits were made overnight. You were either in or you missed the move.

The same is true for individual stocks. Sector rotation is strong and groups are hot today and flat tomorrow. If you are not in early, you missed the move. I am expecting a lot of sector rotation this week. We will see window dressing as the first quarter ends. Some of the strongest sectors could see profit-taking and some of the weakest sectors could see buying. I believe cyclical stocks will catch a bid in the next week or two.

My tone has been very bullish since February and I thought I would temper it a bit with my concluding remarks. In today’s chart you can see that option implied volatilities are extremely low. Bullish sentiment is high and we are setting up for correction. I believe that stocks will rally into the middle of April and then they will stall. Good news will be priced in and we will see profit-taking as the market tries to challenge the all-time highs. I don’t believe it will get close and SPY 146 – 148 will be as high as we get.

Euro interest rates, high energy prices or an economic slowdown in China could spook investors heading into May.

The news this morning was not that good and I can’t justify this rally. Stocks have not advanced since the opening bell and we might see a little selling in the afternoon.

We should have good conditions for three weeks. Stay long and expect a gradual move higher with occasional pullbacks.

If we get a few more days like today, I will be taking profits on my call positions.

I don’t see option implied volatilities dropping much from this level and I will buy VXX when it reaches support (not yet).
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