Maintain A “Buy the Dip” Mentality. Wait For Support and Don’t Get Cute. Too Early To Short

March 6, 2012

Here is a shocker. The market is down overnight because of credit concerns in Greece. Where have I heard that before?

The Greek debt swap deadline is on Thursday and traders are wondering if enough private investors will participate to avoid a disorderly default. Eurocrats are warning that losses of €1 trillion could result if private investors don’t agree to the “haircuts”. From what I’m reading, 90% to 95% participation is expected and that will suffice.

From my perspective, the market is searching for a “driver”. Bulls were not able to break through resistance and now bears will have their shot. The services PMI in China was down over the weekend and that sparked selling yesterday. The market did not recover and we are getting some follow-through this morning.

Global economic conditions are currently stable and credit fears in Europe have subsided. Central banks around the world are easing and inflation is contained. Earnings were decent and stock valuations are attractive. Combined, these forces are tough to fade.

Tomorrow, ADP employment will be released. I’m expecting good results and I’m also expecting a good initial jobless claims number on Thursday. Last week, the Fed Chairman said that employment conditions are improving when he testified before Congress. Jobs are the key to a sustained economic recovery.

Analysts project that 207,000 new jobs were created in February. That is lower than last month’s 243,000 and I believe the estimates for February are conservative. Friday’s Unemployment Report should be able to meet or exceed estimates.

Apple will release a new product on Thursday. The stock accounts for 12% of the S&P 500 rally this year. Traders are likely to “sell the news” and this mega-cap stock could weigh on the market.

Thursday night, China will release its PPI/CPI. Officials believe that inflation could fall to 4% in February, the lowest level in years. This would pave the way for future easing and it would be a “market friendly” event.

Asset Managers do not want to chase stocks after a big run-up. The market did not have enough strength to break through resistance and profit-taking has set in. Bullish speculators will get flushed out in a swift decline. Once support is established, Asset Managers will quickly step in.

The next rally could slingshot us through resistance at SPY 137. Credit concerns in Europe are not currently an issue and Q1 earnings season is a month away. Stocks typically rally ahead of earnings season and a solid jobs report will keep a bid to the market.

This dip should not last more than a few days. There is strong horizontal support at SPY 133. That was the breakout in February and I don’t believe that level will fail this week. A retracement to SPY 130 would set up an excellent buying opportunity.

My long-term outlook is still bearish, but I am not letting it obscure my short-term forecast. The macro influences are currently bullish and it will take time for European credit concerns and deteriorating economic conditions in Asia to manifest. By May, we could set up for an excellent shorting opportunity.

Asset Managers will pull their bids today. They will let the market probe for support. When Greece avoids a disorderly default they will aggressively bid for stocks. A decent ADP report and solid initial claims will be too much to ignore.

My risk exposure is currently small. If I get a nice pop in the VIX today, I will sell some of my March VIX calls. I will scale out of this hedge this week. March expiration is approaching and after the market rebounds, I will buy the VXX. The advantage of owning the underlying (instead of rolling out to April options) is that I don’t have to worry about time decay or expiration.

As for my call positions, I have been rotating in and out of call positions and my gains have more than offset my losses in the VIX calls. Today I will watch the open. If stocks can’t catch a bid late in the day, I will sell most of my March calls and I will wait for an opportunity to buy April calls. If we get a rally late in the day, I will hang on to my March calls through the jobs report Friday.

Since my position has been hedged and my size has been relatively small, I view this decline as an opportunity, not a setback.

Let this wave of selling run its course. Watch for support at SPY 133. If the situation in Greece gets sloppy, we could test SPY 130. That would set up a nice buying opportunity.

Maintain a “buy the dip” mentality and don’t get cute. It is too early to short this rally.
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