Credit Markets Are Improving – Get Long With Caution!

Last week the market had its largest one-day rally and one-day decline - ever. Option expiration added to the volatility and when all was said and done, the market found its footing for the first time in weeks. Extreme measures by central banks around the world are bearing fruit. The credit markets are improving and spreads are coming down. This is the most critical development because it means that banks are starting to do business with each other. For a few weeks, the financial markets had locked up and it seemed plausible that we could have a full-blown collapse in the system. Nothing is currently more important to the stock market. Economic data has been weak, but that has been expected (and priced in). Earnings have been decent for the most part. More than half of the S&P 500 companies have beat earnings expectations. This week the economic data is very light. However, earnings are in full swing. I expect earnings to generate a positive reaction because most stocks are extremely oversold. As you can see in the chart, a short-term support level has been established. The SPY has very minor resistance at 100. If the market can close above that level, it is likely to fill in the gap and rally to 110. The first week of a five-week expiration cycle tends to be rather quiet. We are entering the two most bullish weeks of the year (last week in October/first week in November). Option implied volatility is at historic highs and sentiment is as bearish as I've ever seen it. All of these factors should lend support to the market. I particularly like technology and some of the beaten-down commodity stocks. Hedge funds were forced to liquidate positions when brokerage firms raise margin requirements. These stocks will not reach their previous highs, but they represent a bargain at this level. Even though today's commentary is bullish, keep in mind that I am long-term bearish. That means that bullish trades need to be smaller in size and that stops need to be used. You also need to take profits along the way. I am expecting the market to grind higher the rest of the day.

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