This week’s news events were highly predictable and the price action has been lackluster. The market has inched above SPY 137 and the path of least resistance is higher. With each small rally, under allocated Asset Managers get anxious and they are bidding more aggressively.
The ECB’s second liquidity injection was one of the most anticipated events of the year. We learned that 800 European banks versus 523 banks in December participated. The negative stigma is not much of an issue and they all stepped up to the trough. Euro banks tapped the ECB for €530 billion. Most analysts considered this to be “not too hot — not too cold”.
Interest rates across Europe declined after the release. Bond auctions in Spain went well and European banks will play the “carry trade” on shorter-term maturities. For the time being, credit concerns have been pacified.
Eurocrats are meeting to discuss a giant “firewall”. They want to raise money to prevent contagion. Again, this is a short-term stop gap measure. The longer-term focus needs to be on fiscal reform. European countries have massive structural issues and deficits will continue to spiral out of control. I don’t believe any meaningful fiscal plan will be approved this year.
China and Europe posted their official PMI’s and they were in line with expectations. China’s number came in at 51 (indicating economic growth). Europe’s PMI came in at 49. France and Germany were 50 and 50.2 respectively. Economic conditions throughout the EU are tenuous, but the market did not have much of her reaction to the releases.
Domestic economic releases have been positive. The first revision for Q4 GDP came in better than expected at 3%. Chicago PMI rose to its highest level in 10 months and initial jobless claims held steady at 351,000.
Employment conditions have been improving and that bodes well for next week’s Unemployment Report. I believe the market will have a strong bid ahead of the number.
Chairman Bernanke is testifying before the House. The market declined when hopes for QE3 were dashed. This should not have come as a surprise given the recent improvement in economic activity. Today, that dip has been reversed and stocks are pushing higher.
Q4 earnings growth was dismal at 6.3% and this was the worst showing in over two years. If you strip out Apple, earnings for the S&P 500 only grew 2.3%. In fact, Apple accounts for 12% of the S&P 500 rally this year. Market gains are concentrated and a handful of large cap stocks account for most of the move.
Stock volumes year-to-date are down 5%, option activity is down 6% and commodity trading is down more than 30%. Traders are waiting for a catalyst to break us out of this tight trading range.
Stock valuations are attractive at a forward P/E of 14. Corporate balance sheets are strong and companies are using cash to buy back shares. Interest rates are at historic lows and with the credit crisis off of the table; assets will rotate out of fixed income and into equities.
Jobs will be the focus next week and the results should be decent. If 250,000 jobs are added in February, the market will have the catalyst it needs to convincingly push through major resistance.
I don’t see any news that will spoil this rally. In the final stages of this move, stocks have consolidated and buying pressure is building up.
I am long calls on strong stocks that are rising to the top of the Live Update table in the Daily Report. In particular, I am looking for stocks that have consolidated after a nice run and are breaking out to new relative highs. The momentum will last a few days after the breakout. I am also long VIX calls as a hedge. Option premiums are very cheap and if I get blindsided by a market decline, this position will serve as a hedge. Alternatively, you can consider buying puts on weak stocks in the bearish section of the Live Update table. Focus on stocks that have run up and have broken below horizontal support.
Look for a gradual grind higher today and look for higher prices into the Unemployment Report next week. The gains from this point forward will be hard-fought. Don’t expect massive rallies. Be selective, take profits and move on.