Financial Stocks Are Leading A Rally Ahead Of Goldman’s Earnings!

Two weeks ago, the market broke down after a weak Unemployment Report. It breached critical support at SPY 89. That level represented the 200-day moving average and the neckline of a head and shoulders formation. Since then, bears have not been able to generate any selling momentum. Earnings and economic news was light last week and after a holiday, trading was very quiet. The Treasury auctioned $75 billion worth of new bonds and strong demand pushed interest rates lower. That kept short-sellers at bay and the market was able to tread water. Traders will wait for earnings before they commit capital. This week, Goldman Sachs, Johnson & Johnson, Intel, Yum Brands, Abbott Labs, Charles Schwab, Baxter, J.P. Morgan Chase, Google, IBM, Bank of America, Citigroup and General Electric will announce. This will give us a taste from many different sectors. Analysts expect a 39% drop in earnings this quarter and there is a good chance that more than two thirds of the companies will beat estimates. The market has rallied 40% from its March low and good results are priced in. The guidance for Q3 will be pivotal and the market could swing either way. Financial stocks will be the highlight for the next two weeks. They were the source of the market decline and they have to stabilize before a sustained rally can be expected. This morning, Meredith Whitney (a highly regarded analyst who correctly forecasted the financial crisis) predicted solid earnings for Goldman Sachs and Bank of America. Financial stocks are posting their biggest one-day gains in over six weeks. She feels that the spread between the borrowing rate and the lending rate will help major banks post solid numbers. She feels that Goldman Sachs will do well in fixed income trading and they have been busy underwriting new bond issues. I agree with her assessment and in addition, I am not expecting big write-downs. Banks have the latitude to hang onto toxic assets because of FASB rule changes. While this is clogging up lending, it will help the current quarter’s results. The entire financial sector could test the May highs, but it will quickly run out of steam. Increasing credit card default rates, rising mortgage foreclosures and exposure to commercial real estate will weigh on these stocks as long as the unemployment rate keeps rising. Additionally, many new shares have been issued to raise capital and shareholders have been diluted. The implied volatility in these stock's is high and there are some nice put writing opportunities (be very selective). Intel and Google will set the tone for tech stocks. This sector has been strong relative to the overall market and it must lead the next rally. I feel Intel will have a greater impact on the market than GOOG since it is tied to many other stocks. The SPY is likely to close above the neckline and the 200-day moving average today. There simply isn't enough news or conviction to generate a sustained move in either direction. After a year of extreme volatility, prices have found equilibrium and we could see a fairly tight range until September. The PPI and CPI should be tame this week and I do not expect them to drive the market. Initial jobless claims could spike and that could weigh on the market Thursday. We had a surprise drop last week, but I believe that was caused by the holiday. Many people postpone filing for unemployment until they get back from vacation. Also, continuing claims rose by a large amount last week. In general, these economic numbers will take a back seat to earnings this week. The market was trading near a one month low this morning and that could have sparked sell programs during option expiration. Now that we have rallied back above resistance, that potential has subsided. In fact, decent earnings could spark a round of short covering now that we are back above SPY 89. In summary, this market could go either way and it doesn't make sense to place large bets in this environment. I will be looking for individual stories and I will sell put spreads on strong stocks after the earnings announcements. As long as the SPY stays below 89, I will also consider selling call spreads on weak stocks. For today, advancers outnumber decliners by 3 to 1. The market was able to overcome overnight weakness in Asia and it should stay in positive territory today. Watch the key earnings releases and monitor the market's reaction. Keep your size small!

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