Greek Aid Is On The Way. Market Discounts Credit Risk and Focuses On Earnings!

April 29, 2010
Author: Peter Stolcers, Founder of OneOption

As a fisherman, I know that "the bite" is best just before a major storm. I can see the clouds brewing and I respect the warning signs, but they don't prevent me from "wetting a line". I closely monitor the conditions and I don't chase across the lake to my favorite spot. I stay close to shore so that I can quickly reach safety. This is how I currently view the market. The trend is strong and stocks are moving higher. We are in the final stages of this rally and the headwinds are blowing. I want to participate in the upside, but I am ready to pull the plug at a moment's notice. I am not fully allocated and I want to keep my risk minimal. This week, the market digested another round of earnings and they were fantastic. Almost half of the S&P 500 companies have reported and 70% have exceeded top line growth and over 80% have beaten profit estimates. Traders have been tempted to "sell the news", but buyers are quickly scooping up shares. More than half of the companies that have beaten estimates have rallied after the release. This is a stark contrast to the price action we saw last October and January. Yesterday, the Fed maintained its low interest rate policy. It did not change its rhetoric and that was a major positive for stocks. Strong earnings, solid balance sheet and low interest rates are "market friendly". These forces have allowed traders to ignore everything else. The European credit crisis raised its ugly head this week. Greek two-year bonds spiked to a yield of 19%. The EU/IMF aid needs to come quickly or they will default. That is likely to take place and the market discounted the news. After a 28 point decline in the S & P 500, Prices are right back where they started. A more important development took place this week. Interest rates are climbing in other countries. Portugal and Spain had their debt ratings lowered this week. That means their cost of capital is rising as risk is priced in. Italy held a bond auction early in the week and they barely had enough bids to cover the offering. Without question, the credit crisis is spreading. Greece has been in the news and we know how hard it was them to secure financing. Imagine Germany's reluctance when Portugal, Spain and Italy come knocking. Ireland and England are also in very bad shape. This morning, initial jobless claims came in slightly better than expected (445,000). That number does little to impress and during the last four weeks, job growth has been minimal. That does not bode well for next week's Unemployment Report. Government employment will still drive job growth, but the private sector is slow to hire. We will get a heavy dose of economic releases next week, but jobs will be the focal point. I believe job growth will be tenuous at best, but the market will discount the news. Two or three months of weak data will be needed to shake bullish sentiment. By the end of summer, I expect to see this. Government stimulus will be winding down and state/local governments will be cutting payrolls. Corporations do not want to add to overhead expenses and they will not pick up the slack. The Euro credit crisis will continue to fester and build. However, aid packages and austerity programs will temporarily calm nerves. The PIIGS will be holding major bond auctions (€200 billion) in the next two months and I will be keeping a close watch on yields. If interest rates start to climb, pull anchor and head for shore. This problem is also a few months away from escalating to the next level. SPY 115 is a critical support level. A failure will mark the top of this rally. The “fish” are biting so keep a line in the water. Watch your pole, but don’t lose sight of the horizon. Limit the number of positions and keep your size small so that you can quickly reach safety. For the time being, small pullbacks are a buying opportunity. That all goes away when SPY 115 is breached since that would be a sign to go short. image

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