Worst Case Scenarios Priced In Ahead Of Earnings Next Week – Low Should Hold!

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

The selling that started last week is gaining momentum. We have breached major support levels, the most significant being SPY 85. The decliners outnumber advancers today by an 8 to 1 ratio and the selling is broad-based. Yesterday, a dismal retail sales number shook the market. Revenues were down 2.7% during the busiest time of year. The real blow will come when earnings are released. The sales that did materialize came at deeply discounted prices and profit margins will be squeezed. This morning, we learned that initial jobless claims rose to 524,000. Analysts had been expecting 500,000 and they attribute the increase to the holidays. Workers who lost their jobs postponed filing and now those claims are being processed. Continuing claims stand at 4.5 million and economic conditions continue to deteriorate. US foreclosure rates jumped 81% in 2008 with one in every 54 households getting a filing notice. This problem will continue to get worse as the unemployment rate rises. Bank stocks have been falling and analysts believe that they will need another TARP infusion. Deutsche Bank announced that they would take a $6 billion write-down this quarter. It's conceivable that HSBC will need $30 billion in new capital. Citigroup is selling assets to generate cash and Bank of America is choking on its Merrill Lynch acquisition. Goldman Sachs believes that financial institutions could lose $1.6T in 2009 and they believe that is a conservative estimate. The first round of earnings releases will be dominated by financial stocks. J.P. Morgan Chase, one of the strongest stocks, beat earnings estimates. It posted a gain of $.07 per share. If not for the Washington Mutual acquisition, they would have posted a loss. Worst case scenarios are being priced in and it is possible that financial stocks will hold these levels after they release. Next week, the economic releases are light and all eyes will be on earnings. The current quarter will be weak and that is factored in. The guidance will be the critical component as analysts try to gauge the depth and duration of this cycle. My suspicion is that many companies will not provide guidance due to uncertainty and that will add to the current lack of transparency. After earnings are released, I will write puts on stocks that have solid support levels and operate in a stable niche. The market is falling towards the November lows. The initial wave of selling passed in 2008 and cash ($9 trillion) is parked on the sidelines. The credit spread (the differential between US Treasuries and junk) has been narrowing and the appetite for risk was showing signs of improvement two weeks ago. I am long-term bearish, but I believe that the November lows will hold during the first quarter of 2009. There is no reason to stick your neck out. Wait for earnings next week and look for signs of market support. Identify pockets of strength and be ready when the time is right. Selling out of the money puts is the best strategy. The premiums are extremely high and there are bargains. The key is picking the right stock. The market has been in a steady drift lower today and I don't believe we will see a reversal. Don't get fooled by a mid-day rally. Option expiration is having a negative influence on the market now that support has been broken and sell programs lurk. image

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