Expect Choppy Trading While Economic Conditions Deteriorate – Get Short Below SPY 108!

Yesterday, the market sold off after testing resistance at SPY 112. Europe is casting fear on the market. Germany, the strongest and largest EU member reported that business sentiment declined in February. Two weeks ago it reported that Q4 GDP was flat. These results were confirmed when Commerzebank (second largest German bank) reported a large loss yesterday. The credit crisis in Europe is spreading. Greece will need to issue new debt soon, but it is afraid to. After their last bond auction, interest rates spiked and a huge risk premium was priced in. The demand for a new auction could be horrible. Portugal tried to offer bonds after Greece's auction and they could not even fill a one-year, $1 billion issue. The EU has warned Greece that it needs to drastically cut costs and demonstrate that it can balance its budget. It has until mid-March to prove itself. If it fails to do so, the EU will not provide aid. As the government prepares to take action, laborers are striking and they could cripple the country. This will not sit well with investors should a new bond auction come to market. We have our own bond auctions to deal with this week and they are the largest ever. Today, the treasury will try to sell $42 billion worth of five-year notes and tomorrow they will try to sell $32 billion worth of seven-year notes. Europe's woes are creating demand for our bonds (flight to safety). However, our average maturity date is four years and we will continually be refinancing our debt. No one wants to lend our government money for a long period of time that these low rates, so we keep issuing short term debt. China has been selling US treasuries and that could materially affect our interest rates. We have relied on China to finance our debt and if they do not participate, the demand will have to come from other sources. Not many other counties have the cash to support our needs. If China is net seller of our debt, it is a double whammy. They will be competing with our auctions, further driving down bond prices and increasing the cost of capital. The bond auctions today and tomorrow will be important. I am not expecting a poor showing. There is too much fear and US Treasuries are still considered a safe place to "park money". If that sentiment changes, we could be in big trouble. There aren't any serious attempts being made to curb our spending. The best Obama could come up with was a price freeze on a sliver of our annual budget. He wants to push through health-care reform and that is projected to cost at least $200 billion per year. Everyone knows those estimates are ridiculously low and they include all sorts of projected price savings. If foreign investors sense that our debt will escalate, the demand for our bonds will fall. Tomorrow, initial claims and durable goods will be released. I am not looking for a disastrous number, but jobless claims could creep higher. A few weeks ago, businesses reported an increase in planned layoffs. We could start to see signs of that happening. Durable goods orders are extremely volatile and they are taken with a grain of salt. Analysts expect a 1.4% increase. Friday, GDP will be released and if there are not dramatic changes, the market will react positively. Traders also don't want to short the market before the weekend. Monday's have been particularly strong and M&A activity is picking up. I expect the market to tread water for a week or two. Selloffs like the one we saw yesterday will not generate a sustained move. Weakness in Europe, poor bond auctions in the US, higher unemployment or a slowdown in China is the catalysts we need for a big decline. Be patient and wait for a breakdown below SPY 108. We are likely to see choppy two-sided action while conditions deteriorate.

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