The Financial Sector Sparked A Rally – Look For Follow Through!

As I had mentioned in yesterday's market commentary, a short covering rally will starts in the financial sector this week. Overnight, Citigroup said it has realized an operating profit of $8.3 billion before taxes and special items through February. That number does not include write-downs and one has to wonder about that critical missing piece of information. In any case, the market has fundamental news it can sink its teeth into. Most rallies have been unsustainable and after the first day, they fail. This one could have legs. It is not predicated on a future stimulus package or a bailout. The financial system is the kingpin to an economic recovery and signs of stability will gradually restore confidence. China has regained its footing and their PMI rose for the third straight month. They have also doubled their stimulus plan (which they can afford) and commodity prices are starting to rise. These fundamental signs of improvement will have a lasting effect. Later this week, there is a chance that mark- to-market accounting will be temporarily abandoned. That would improve bank balance sheets and they may be more inclined to lend knowing that their reserves are adequate for the time being. This change would not cost the government a dime and it is worth a shot. Unfortunately, it doesn't change the fact that financial institutions are laden with a pile of garbage that they will need to deal with. As credit markets improve, they should be required to take their losses. Once the toxic assets are cleaned up, mark-to-market should be reestablished. This accounting practice lends transparency to the financial state of the bank. The market is deeply oversold and we are due for a considerable short covering rally. The middle of March has historically been bullish. If we can sustain a rally for the next day or two, the bears will start to respect this move. That would also set us up for a potential quadruple witching rally next week. Earnings season is over and the economic calendar is fairly light this week. That means that there aren’t many hurdles this week and today’s rally could gain traction. On a long-term basis, don't lose sight of the fact that this is nothing more than a bear market rally. They can be fast and furious and they exceed expectations. The key resistance levels are SPY 75, 85 and 92. I don't think the market will have much trouble getting through the first level. The second level can only be penetrated if good fundamental news continues to materialize. SPY 92 is a stretch and it represents a 30% rally from the low. Economic conditions are horrible and they continue to deteriorate in the US and Europe. An Eastern European bank failure seems eminent and that could spoil this rally in an instant. Unemployment is the other key factor and the rate of acceleration is unprecedented. We need to see employment stabilize. The first signs will come when the weekly initial jobless claims improve sequentially. I have mentioned that selling naked puts and out of the money put credit spreads has been my strategy of choice. I have been adding to positions and by the end of the week I will have 75% of my desired risk exposure. The market is still volatile and I want to distance myself from the action. In today's chart you can see that the VIX is dropping. By selling puts, I am taking advantage of time decay and a decrease in implied volatility. I am focusing on commodity stocks and cyclical stocks that have formed solid bases and have held up well during the recent market decline. They also need to have strong balance sheets and decent earnings. I expect this rally to continue for at least another two days. This will not be a "one and done" bounce.

Daily Bulletin Continues...