In the last few months the market as staged a big rally and it has run up to a major resistance level. The news has been excellent and stocks need time to consolidate gains. Earnings season is less than a month away and we will see strength ahead of the announcements.
Economic releases in Asia have been soft, but not devastating. China is still growing at a robust pace and inflation has dropped to its lowest level in years. The PBOC is likely to ease and Asian stocks will catch a bid.
Europe is in a recession and economic activity will be suppressed by austerity. Private investors swapped Greek bonds last week and a disorderly default was avoided. The ECB has been flooding banks with money and they now have an extra €1 trillion to play with. Short-term sovereign bond auctions will go well and European credit concerns are temporarily off the table.
Economic conditions in the US are improving. Jobs are being created and activity is on the rise. Recent releases have been good (Unemployment Report, ADP, initial claims, GDP, ISM services, Chicago PMI and retail sales). The economic releases this week are light and Thursday will be the busiest day (initial claims, Empire Manufacturing and the Philly Fed).
Fourth-quarter earnings season has ended and the results were fair. Profit growth has slowed to its lowest level in two years, but stock valuations are attractive. The S&P 500 is trading at a forward P/E of 14.
Interest rates are at historic lows and the Fed plans to keep them that way for the next two years. Central banks around the world will be releasing statements this week and they will be “dovish”. Asset Managers will be shifting out of fixed income and into equities now that global credit concerns have been pacified.
The financial sector has led the recent market rally. After the close Thursday, the results from the recent bank stress test will be released. Bad debt write-downs are decreasing and banks are foreclosing on delinquent home loans. Their toxic assets are declining and good results from the stress test could propel the market.
I don’t see any speed bumps this week. Traders are looking for any reason to sell and they can’t find one. Asset Managers would love to buy a dip but they won’t get one. Under allocated Asset Managers are playing “catch up” and that means the pullbacks will be shallow and brief. Last Tuesday’s decline is a classic example.
By the same token, the market rests just below major resistance. Investors are not going to chase stocks at this level.
I believe the price action will follow this pattern. The market will sit in a tight trading range for a number of days and then a good news event will spark overnight buying. The market will gap higher and then it will sit. If you are not long overnight, you won’t participate.
This is a very boring market to trade. We are caught in a tight range and stocks need time to consolidate gains. In a few weeks, Asset Managers will see that they are not going to get a pullback. The market will gather strength and it will break out ahead of Q1 earnings season.
I am bullish in the short run, but that does not change my long-term bearish perspective. Central banks can keep this Ponzi scheme going as long as everyone plays nice in the sandbox. When the weak link comes back into focus, the whole chain will break.
Deficits are enormous and structural issues have not been addressed. Every day I keep a very close eye on European interest rates. Japan is also on my radar.
Stay long and keep your size small. If we get a pullback, add to positions. I don’t want to buy into this breakout until we get closer to earnings season. That extra buying pressure will decrease the chances of a surprise pullback and I want to have that force working in my favor.
Look for a gradual grind higher throughout the day. The strength in Asia bodes well for cyclical stocks.