The Numbers Weren’t That Bad – This Is Porfit Taking – Look For Support Tomorrow!

The market is finally starting to feel a little heavy. Ever since the key reversal last Wednesday following the FOMC statement, profit-taking has set in. As I've been mentioning, nervous trading should precede the Unemployment Report. The economic news this morning was not dire enough to justify a 20 point drop in the S&P 500. Construction spending increased 1.8% in August and that was better than expected. Private residential construction spending rose 4.7% and that is an encouraging sign for builders. Pending home sales increased 6.4% last month and that was also better than expected. From 2001 through 2005, 50% of our employment growth (including builders, realtors, lenders...) came from the housing boom. Construction is critical to an economic recovery. Interest rates and home prices have plummeted and the conditions don’t get much better for buyers. Consumer spending was up 1.3% last month and that is the largest gain since 2001. Consumption makes up 70% of our economy and this is also a critical recovery component. ISM manufacturing came in at 52.6 indicating economic expansion. It was down slightly from August's number, but it was positive nonetheless. Initial jobless claims were the real culprit behind today's selling. Jobless claims increased by 17,000 week over week and they came in at 551,000. Analysts were looking for 535,000 job losses. Continuing claims dropped by 70,000 and that was a positive. Employers reduced planned job cuts by 13% from August's level and that is also a positive. Week-to-week initial claims numbers are volatile and most analysts prefer to look at the four-week moving average. It dropped by almost 6000 and that is also encouraging. In total, initial claims were not that bad and I suspect that trades simply want to take some profits. All eyes will be on the Unemployment Report tomorrow. Consensus estimates are for a decline of 180,000 jobs in September. Given the initial jobless claims today and the ADP employment index earlier in the week, there is room for disappointment. Anything below last month's 216,000 should receive a positive market reaction. Traders are nervous and they want to see continual improvement. Jobs are the key to economic recovery and "less bad" results have been acceptable – so far. The market has broken below support at SPY 105. The more important level from my perspective is SPY 100. If that level is breached, the market will have established a lower low and major resistance at the recent high will have formed. A more likely scenario is that the market will decline on a weaker than expected Unemployment Report and recover some of its losses throughout the day. M&A activity is starting to return and shorts will not get too aggressive heading into "Merger Monday". Perhaps the most critical economic data for the week will be released Monday morning. ISM services is expected to come in at 50.0. That would indicate that we are on the brink of economic expansion. This number is very important because 80% of our activity comes from services. Last month it came in slightly below expectations at 48.4. Next Wednesday, Alcoa will release results and earnings season will officially begin. Financial stocks dominate the first two weeks of releases and I believe they will post solid numbers. They will benefit from a huge spread between their borrowing and lending rates. Their write-downs have subsided and "marked to model" accounting changes have allowed them to inflate their balance sheets. Earnings and revenues should look good year-over-year across all sectors since this recession is more than a year old. Optimism will spread and this will be the catalyst for the final stage of this rally. Interest rates are low and as long as the economic numbers continue to show gradual improvement, the market will rally. Asset Managers that are under allocated are aggressively bidding for stocks so that they can catch up to their benchmarks. Consequently, I believe this decline will be relatively short. If I am right, the market will find support tomorrow above SPY 100 and we will rally through SPY 105 next week. In two weeks, we have a chance to make a new relative high. If the SPY easily falls below 100, I’ll know my forecast is wrong and I'll adjust my positions. I am not aggressive at this stage and I have been selling out of the money put credit spreads on strong stocks. I have one third of my desired position on it this time and that will add another third if the market finds support tomorrow. The volume has been relatively low the last few weeks and earnings season will bring activity back to its normal level. Be patient and "buy the dips" once support has been established. Traders have been trying to time a top for months and in each case, they have been wrong. The market will tell us when it is ready to roll over and we will wait for a technical breakdown before we start looking at shorts.

Daily Bulletin Continues...