This week, the market has shown its strength. Monday, it shrugged off the possibility of a Swine Flu pandemic. Unlike most viruses, this one had a particularly high mortality rate and it was spreading quickly.
Yesterday, a much worse than expected GDP decline did little to dampen spirits. Economists had expected a decline of 4.8% and economic activity actually dropped to 6.1%. Bulls found a silver lining in the 2.2% rise in consumption. A drawdown in business inventories was also seen as positive. Without an uptick in demand, I don’t share that view.
The FOMC released its statement and as expected, they will keep the Fed Funds Rate near the 0% target. They reiterated their commitment to buy treasuries if interest rates start to rise. The market does not mind that the printing presses could be turned on soon.
This morning, initial jobless claims fell slightly. However, continuing claims rose to 6.3 million, the highest level ever. The market is on a mission and it has completely discounted economic news.
Bulls argue that economic statistics are backwards looking and they do not reflect current conditions. If that were the case, I would expect corporations to cautiously mentioned improving conditions during their conference calls. Instead, they are reluctant to provide guidance and Q2 visibility is poor.
More than 30% of the S&P 500 companies have reported. A whopping 69% have exceeded earnings estimates. However, it’s important to note that the bar has been set very low by analysts. They were forecasting a 34% drop in earnings this quarter and a 33% drop in earnings next quarter.
The market has broken out to a new three-month high. The headwinds will grow stronger as it approaches resistance at SPY 92. The bulls have the momentum and shorts are covering. This market will continue to work its way higher, but I expect a two steps forward, one step backwards pattern to develop.
As the market tries to break out, the danger of a reversal looms. When investors start to pile back in, a big decline is possible and it will flush them out.
Next week, the government will release the results of its “stress test”. It evaluated 19 of the country’s largest banks (they control 60% of the assets). Rumor has it that all but a few will pass. I would not expect the government to release news that could jeopardize the financial stability it has worked so hard to secure. Bears will not want to head into this weekend short.
The momentum clearly favors the upside and there are great opportunities everywhere. In the back of your mind, remember that we are in a long-term downtrend. Bear market rallies are fast and furious and they can climb much higher than anyone ever imagined. The market backed off from its rally late yesterday and it is off of its highs this morning. Be patient establishing long positions and wait for the market to come in. Also make sure to have stops in place. I don’t trust this market and I am making great money selling put credit spreads. I am far from the action and I don’t have to sweat every tick. Option premiums are still rich and that also favors this strategy.