Buy the Breakout – Keep Option Trades Small – Fed Signaling Trouble Ahead.

May 1, 2008
Author: Peter Stolcers, Founder of OneOption

Yesterday, all eyes were fixed on the Fed’s interest rate policy and their statements. As expected, they lowered rates by .25%. The ensuing comments were very "dovish" and that was not expected. The Fed stated that economic conditions continue to be weak and that the possibility of future credit problems exists. They also stated that inflation is a concern, but they see signs of moderation. This statement is much more cautious than I expected and the Fed is not remotely leaning towards a rate hike. As I mentioned in yesterday's comments, "dovish" statements could be signaling trouble ahead. The Fed will not meet for another two months and effectively we have a rate cut pause. I believe tomorrow's Unemployment Report will come in on the weak side. During the last three weeks, initial jobless claims have been moderating and that is a good sign. That was not the case today. Jobless claims rose by 35,000 to 380,000. What's more concerning is that continuing claims rose above 3 million and that is the highest level since April of 2004. In a survey conducted by Challenger Gray and Christmas, planned job cuts rose to a 19-month high and they rose 68% in the last month. This signal weakness ahead. If people lose their jobs, the credit crisis will spread beyond subprime loans. The other economic news came in mixed. Construction spending was down 1.1% and that was weaker than expected. The ISM manufacturing number came in slightly better than expected at 48.6. On a positive note, tech stocks are posting an excellent rally. As you can see in the chart today, the QQQQ is making a new relative high. In order for the market to mount a sustained rally, tech stocks must lead the way. Lower energy prices would also help to fuel this rally. The market is trying to stage a breakout. Money is rotating out of commodities and into other sectors. That is a healthy sign, however, I am skeptical. I feel that underperforming sectors will continue to underperform. Those stocks were pushed down to oversold levels and a bounce was justified. Once the shorts cover, they will resume their down trend. Housing, financial, retail and restaurant stocks will eventually rollover and continue their downtrend. Economic conditions are still relatively weak and we are not out of the woods yet. Conversely, commodity stocks were a safe haven and they got way ahead of themselves. Once the fast money has been chased out of commodity stocks, they will resume their long-term up trends. The dollar is also in an oversold state and it is due for a short covering rally. The dollar has an inverse relationship to commodities and once that bounce runs its course, commodity stocks will be back in favor. Our national debt is extreme and the Fed has the printing presses running 24/7. A sustained dollar rally is unlikely under these conditions. On a relative basis, the Euro is much stronger due to the ECB’s steadfast interest rate policy and they will not lower rates anytime soon. I expected the market to rally given yesterday's dovish statements by the Fed. As I mentioned, take this as a sign that trouble lies ahead. Today's rally has a chance of continuing right into the bell. I fear that a weak employment number tomorrow could be in the cards. After an initial drop, the market might have enough strength to recover. I would only trade this rally and small size. Take profits as the market approaches SPY 145. I am short term bullish and I like the tech rally. I also like heavy equipment manufactures. I suggest trading these two groups while patiently waiting for commodity stocks to find support. image

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