The Early Rally Is Fading – The Market Is Tired!

Last week, bulls had the perfect opportunity to squeeze shorts. The market was near a major resistance level and a small push higher would have fueled a massive rally during option expiration. That scenario did not unfold and the upward momentum has vaporized. In each of the market declines that we've seen in the last two months, the market has staged an immediate rebound and it has moved to new relative highs. That was not the case last week and investors are tired after a 40% retracement from the March lows. Market catalysts have run their course. The government has been busy with bailouts, stimulus plans, stress tests and mortgage lending. The kitchen sink has been thrown at the financial crisis and a meltdown has been avoided. Banks are starting to turn a profit and they have jumped from there March lows. They have also been able raise capital. Today, State Street Bank said it is issuing $1.5 billion in stock to pay off TARP. Economic data is still on the decline, but at a slower pace. Bulls have viewed this as a positive development. China expects their economy to grow 7% in Q2 and their stimulus plan seems to be working (but they have the cash to pay for). As a result, commodity prices have been driven up. Now that the market has run up, it is looking for the next "driver". The government's grandiose plan has to be financed. In the coming months, the U.S. Treasury will issue billions of dollars of new debt. As they do so, interest rates will climb. That will put the economic brakes on the recovery. All of the bad decisions that brought us to this point won't simply fade away into the sunset. Someone still has to pay for all of these mistakes. Debt laden corporations are also taking advantage of this rally through secondary offerings. The new supply of stock is dilutive to existing shareholders and it will keep a lid on stock prices for quite some time. This morning, the elections in India went well and global markets are embracing the victory. Communism has been gaining popularity in the world's most populated country and the party took a blow this weekend. Capitalism and freedom are always good for the market and this development is significant in an unstable part of the world. Lowes posted good earnings this morning and that has helped retail stocks today. After the initial surge, the stock has backed off from its intraday highs. This week, many retailers will release earnings and I expect the same type of price action. The entire sector has staged a huge rebound from its lows and I believe we are set up for disappointment. I believe retail stocks will retreat this week and that will weigh on the market. Economic releases are light. Wednesday we will get the FOMC minutes. I'm not expecting any surprises there. Thursday, initial jobless claims will be released. Rising unemployment remains the biggest concern for investors and the jobless rate has rocketed to 8.9% very quickly. Trading volume should drop off dramatically as the Memorial Day weekend draws closer. The market needs to hold its 20-day moving average. If this level fails, we are likely to test SPY 83 in the next two weeks. Seasonality could play a role as investors "sell in May and go away". Gainers outnumber decliners today by a 4 to 1 margin and I expect the rally to hold. However, prices have stalled and I don't expect further action to the upside today. As the week progresses, selling pressure should increase. I am currently writing out of the money call spreads on retail stocks and defense stocks.

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