This Market Breakdown Looks Like The Real Deal!

June 15, 2009
Author: Peter Stolcers, Founder of OneOption

The market has been in a very tight two-week trading range. Bulls were not able to add to gains and every time they try to stage a breakout, sellers stepped in. Likewise, the market tried to break down and each time, buyers supported prices. A tug-of-war of this nature ends with a victor and typically a substantial breakout/breakdown. There isn't any major news to justify the big decline this morning and in my eyes that makes it even more legitimate. Decliners outnumber advancers by an 8:1 margin and I do not believe we will see a snapback rally this afternoon. If we close below SPY 93, selling will continue tomorrow. There have been a few subtle changes that I've noted recently. The market has stopped rallying on Fridays and Mondays. Bears are more comfortable shorting ahead of the weekend. Also, bad news is once again bad news and the “silver linings” have lost their punch. Finally, the most recent market rally was very narrowly based. Commodity stocks and a handful of big cap tech stocks were pushing it higher. When commodity stocks rally, inflationary pressures are soon to follow. This week we will get the PPI and CPI reports. The expectations for inflation are low and these numbers have the ability to surprise on the "hot" side. Deteriorating economic conditions, rising interest rates and inflation are a lethal combination. We were able to get through last week's bond auctions unscathed. However, these auctions will occur every other week and the Treasury needs to fund more than $1 trillion. That means bulls will continually be trying to dodge bullets. In the last month, mortgage rates have climbed more than 1% on a 30-year fixed loan. This will stifle a housing recovery and home building stocks should come under pressure. Financial institutions have issued stock like mad and shareholders have been diluted. The additional supply of stock will keep a lid on this sector and it will not push the market higher. Retailers have also staged a nice rebound and improvement is already priced in. This sector is also rolling over. I don't see any "drivers" to push the market to its next level. After a 40% rally from the March lows, we are overdue for a pullback. Bullish sentiment has been strong and a breakdown below SPY 93 could flush out the latecomers. The Chinese rebound is nice, but one country cannot pull the rest of the world out of a deep recession. Debt levels are extremely high around the globe and credit risk is elevated. There is still a chance that we will see one of the Eastern European countries default on their debt. That could send a shockwave through Europe. Better-than-expected earnings and economic "green shoots" have been priced into the market. I have been waiting for a breakout or a breakdown. Today's action is very convincing and if it looks like we will close below SPY 93, I will start buying puts on defense stocks and restaurant stocks this afternoon. Homebuilders also look like a good short as interest rates continue to climb. I will continue to add to positions once the market confirms that it is heading lower. image

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