Head & Shoulders Has Formed. Don’t Take Big Positions Ahead Of Earnings Season!

July 6, 2009
Author: Peter Stolcers, Founder of OneOption

This morning, the market is extending losses from Friday's weak Unemployment Report. The jobless rate rose to 9.5% and the economy shed 100,000 jobs more than expected. Until now, bulls have been able to discount the number calling it a lagging indicator. Month after month, the number has disappointed the Street and last week's number was the straw that broke the camel's back. The market has rolled over and a head and shoulders pattern has formed. If we close below SPY 89, the selling momentum will accelerate. There aren't any major economic releases this week and earnings don't really crank up until next week. This morning, ISM services came in at 47 when analysts had expected 46. That is encouraging, but it is still below 50 indicating contraction. Higher interest rates, credit card defaults, home foreclosures, and high debt levels are a few of the themes weighing on investors. Second quarter earnings start this week and they will determine market direction for the rest of the summer. Last quarter, analysts expected a 34% decline in earnings and 70% of the companies beat expectations. In Q2, analysts expect earnings to decline by 39% and I believe we will see many "beats" again. After a 40% rally from the lows in March, the market has priced in decent results. Guidance will be the key. Many corporations expected an economic recovery in the latter half of 2009 and they did not lower their fiscal estimates. We have not seen much a recovery and I fear that we may see downward revisions for 2009 earnings heading into September. The first two weeks of earnings season are heavily weighted in the financial sector. Banks are reluctant to take write-downs and they are sitting on a mountain of toxic assets after FASB rule changes allow them to do so. The spread between their borrowing rate and their lending rate is as wide as I've ever seen and I am expecting good results. However, I am not expecting financial stocks to shoot higher. They have raised a tremendous amount of capital in the last quarter and shareholders have been diluted. It will take many good quarters to get the stocks moving higher. Increasing credit card default rates and exposure to the commercial real estate market will haunt many banks. This week, $75 billion in longer-term Treasuries will be issued. Any rise in interest rates will be bearish for the market. I expect choppy action that favors the downside. I have been suckered in to shorting this market once before and I am reluctant to buy puts in this post holiday environment. I am keeping my powder dry and I have a handful of small put positions. I like shorting defense stocks and steel stocks (with tight stops). Decliners outnumber advancers by 3 to 1. After early volatility this morning, the market has settled down. I expect it to chop back-and-forth on light volume the rest of the day and it should favor the downside. Keep you size small. image

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