Bulls Are Working Too Hard – Can’t Break Through Through Resistance!

December 11, 2008
Author: Peter Stolcers, Founder of OneOption

In the last two weeks, the market has shown remarkable resilience. It has fended off every piece of bad news. All of the economic releases have come out worse than expected and bears have not been able to push the market lower. Today, the initial jobless claims number shot higher by 58,000. That was the biggest spike since September 2005. Continuing claims also rocketed higher from 4.09 million to 4.43 million. This is the highest rate in 26 years and it means that people are not able to find work. One in ten Americans is currently a month behind on their mortgage or they are in foreclosure. As the unemployment rate rises, the subprime crisis will spread to traditional loans. Credit card companies realize this and they are trimming credit lines. The problem is debt and it spans from the government down to individuals. The solution is a higher savings rate. Deflation accomplishes that objective. As prices fall, people postpone their purchases. They expect to buy goods at lower prices in the future. Unfortunately, this means that the economy slows down dramatically and it takes years to recover. Americans have not put money aside for a rainy day and this crisis is coming back to haunt them. For the last 30 years, we have been spending more and saving less and it is going to take us a long time to pay off our debt. Over 70% of baby boomers have less than $100,000 saved for retirement. Many Americans are counting on Social Security and the equity in their house (which is declining and is negative for 1 out of every 6 homeowners) to fund their "golden years". In 10 years, 100% of our national budget will go to paying Social Security and interest on our national debt. If we halt Social Security payments, the majority of baby boomers will die in poverty. If we stop paying interest on our national debt, our financial system will collapse. One of these two has to give. We can fund both for a short time, but there is nothing left over! Our national debt will continue to grow and that window will be moved up as new bailouts surface. Many states are close to running through their unemployment funds and the Fed will have to help out. As people lose their jobs, tax revenues will decrease and the budget deficit will grow. We are in jeopardy of losing our bond rating and Standard & Poor's has already fired that warning shot. If our cost of capital goes up, that 10 year window will move even closer. This is a freight train and I don't know how it can be stopped. The Fed wants to print money by buying US Treasuries. They feel that they can inflate prices and slam on the brakes when prices get "too hot". Politicians were not elected to tell people that they have to suffer and that pain lies ahead. People expect elected officials to fix the problem. As a result, our debt problem is going to be fixed with more debt and we will try to spend our way out of it. I feel sorry for Obama because he is faced with an impossible situation. These conditions have me long-term bearish and if we can temporarily work our way out of this mess, the market will rally. I doubt that we will see a sustained rally of any great magnitude. Too many smart people see this freight train and they are not piling back into stocks. On a short-term basis, the market has found support at SPY 85. Year-end bullishness could spark a short covering. Asset Managers will want to "goose" the market so that 2008 losses are not quite as devastating. I expected to see a rally this week, but we have fallen into a very tight trading range. This tells me that overhead resistance is significant. After a big decline in June and July, the market fell into a trading range in August. During that time, the bad news continued to mount and the market held its ground. Finally, the bears had enough ammunition to push prices lower in September. I hope to see a nice year-end rally because it will set up a great shorting opportunity. I take no pleasure in writing this gloom and doom. I can’t fix the problem, but I can live within my means and hopefully, I can help us all make some money on the way down. The bulls have been given the ball and they are not making any progress. We needed to see a rally this week above SPY 100 and we did not get it. By next week, the bears will regain their confidence and they will take over. Option expiration will weigh on the market as will earnings from Best Buy, FedEx, RIMM, Goldman Sachs and Morgan Stanley. It is possible that the market will stay in a tight trading range the rest of this year as trading volumes decline. In any event, the best current strategy is to sell rich out of the money option premium. I am currently favoring put writing and put credit spreads. However, if we get a nice rally, I will start selling out of the money call credit spreads as well. image

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