Yesterday, the market broke out of its tight trading range, but it still has not been able to rise above major resistance at SPY 137. Good economic releases provided a catalyst and that momentum is pushing stocks a little higher today.
Credit concerns in Europe have subsided. In two weeks, the ECB will provide another massive liquidity injection ($500 billion) and banks will be able to pledge sovereign debt to secure three year loans. For now, the market is content with the maneuver and it is ignoring long-term structural problems. Greek bailouts have not been secured, but the market is not concerned.
Earnings season is winding down and the market is satisfied with profits. If you strip out Apple’s earnings, net income for the S&P 500 only grew 2.6%. This is a miserable showing and it is the lowest level in 2 years. On the bright side, stock valuations are attractive and that’s all Asset Managers are focusing on.
Next week, retailers will dominate the earnings scene. Stores were open longer and expenses increased. The discounting was heavy and that will also bite into profit margins. I believe the news will be mixed with an overall negative bias.
With earnings and the credit crisis out-of-the-way, economic releases will get all of the attention. In Asia, the Bank of Japan is going to start around of quantitative easing. China believes that inflation will decline to 4% in February and that is the best level in two years. They could also start easing. The growth rate has stopped declining in China and that is also a positive sign.
In Europe, industrial production and GDP were in line this week. Germany and France are keeping their heads above water while the rest of the EU is declining. For the time being, the market seems satisfied with the overall activity.
Domestic economic releases have been strong. Empire Manufacturing, Philly Fed and housing starts all exceeded expectations. The biggest news came yesterday when initial claims dropped to 348,000. Jobs are the key to an economic recovery and the market loved this news.
The calendar will be very light again next week. On Wednesday flash PMI’s from Asia and Europe will be released. That will be the biggest news event of the week and it could spark a short-term move.
Monday the market is closed for President’s Day.
Asset Managers don’t want to chase stocks at the top of the range, but they will buy dips. The market has small spurts higher and then it sits. This “what have you done for me lately” pattern will continue until we get a major news event.
If this sounds like I’m getting long-term bullish, I’m not. I am long calls on strong stocks and that position is hedged with calls on VIX. My exposure is small and I am waiting for a breakout or a breakdown.
Domestic economic activity is improving, but it is not that good in Asia or Europe. Earnings growth slowed considerably and the recent market rally is concentrated in a handful of stocks. Credit conditions in Europe can change quickly and banks might not use their loans to purchase sovereign debt.
I am riding this bullish wave, but I am ready to pull the plug at anytime. If we get a nice little pullback, we will probably get a rebound to a new relative high. Once that move exhausts itself, I believe economic activity and credit conditions will push stocks lower. We are probably two months from that inflection point and I will be watching interest rates in Europe very closely.
This could be one of the most boring option expirations in recent memory. Look for quiet price action and a narrow trading range.