The Bears Have The Ball and Major Support Is Being Tested!

July 7, 2009
Author: Peter Stolcers, Founder of OneOption

Yesterday, the market declined early in the day and selling pressure from Thursday's weak Unemployment Report continued. As the day wore on, prices stabilized and buyers pushed the market back into positive territory. ISM services came in stronger than expected. Analysts had projected a reading of 46 and the number actually came in at 47. ISM services has steadily improved over the last few months and this might have provided a small spark to the market. The economic news this week is very light and initial jobless claims on Thursday will be the highlight. We are not seeing an improvement in employment as many had forecasted. Conditions continue to deteriorate and job losses are having a cascading affect on the economy. Mortgage foreclosures are on the rise and Freddie Mac and Fannie Mae reported that 3.4% of all loans are in foreclosure. That is up from about 1% a year ago. Credit card default rates are also rising and Bank of America reported that 12% of their loans are at risk. They also believe that number could double before this economic cycle runs its course. Rising unemployment is also weighing on consumption. People are not spending money when they have taken wage cuts and they fear a layoff. From a technical standpoint, a head and shoulders pattern has formed. The neckline is just above SPY 88 and that also represents the 200-day moving average. Consequently, a major support level will be tested this week. If we break below it, the selling pressure will increase. Sentiment has started to shift. People are questioning the government's stimulus plan and our ability to pay back debt. On the state level, California is issuing IOUs. It can't agree on a budget and the state is out of money. To put this into perspective, if California were a country, it would rank sixth in the world in terms of GDP. Illinois currently has a $9 billion deficit and they can’t balance the budget. Many other states are deep in the red as well. The negative news is building and the only savior is corporate earnings. Companies need to post solid results in the next few weeks or we will break down. After a 40% rally from the March lows, expectations are high. Companies will beat estimates, but will it be enough to push stock prices higher? This week, $75 billion in longer-term Treasuries will be auctioned. Any rise in interest rates will be bearish. This is perhaps the biggest piece of information this week and the results will be released around noon Tuesday, Wednesday and Thursday. Bears clearly have the upper hand at this stage. I believe the next market move is lower, but I am not looking for a retest of the March lows. We should find support around SPY 83. Banks have reduced leverage to a very conservative level and they have attracted new capital. The chance of a financial collapse is minimal and we will not see panic selling. The selling we experienced last fall was from a highly leveraged position when liquidation was forced. Keep your eye on the bond auctions. If interest rates creep higher, the market will break below SPY 88. If it does so, sell out of the money call spreads on weak stocks. I like shorting defense stocks. During this light volume trading, keep your size small. Decliners outnumbered advancers by 3 to 1 and we should see a negative day. There is not any good news to spark a rally today. image

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