Great Earnings and Option Expiration Short Covering – Fuel A Breakout

April 18, 2008
Author: Peter Stolcers, Founder of OneOption

Let's cut to the quick today. The market dodged a major bullet this week when it got through earnings releases from a major banks and negative economic news. At this juncture, it's all about earnings. Worst-case scenarios were factored in by analysts and stocks are handily beating lowered estimates. The guidance has also been good. I've been stating for over a month that corporate earnings (minus financial stocks) posted an 11% increase last quarter. This week, INTC, IBM, GOOG, HON, CAT, UTX and many others have posted solid numbers. I mentioned in yesterday's report that Google had a good chance of beating. The estimates were way too low and the research report last month that forecasted lower click through rates was wrong. This morning, Honeywell and Caterpillar demonstrated that they did not have the same financing issues that plagued General Electric last week. All of this news created massive buying before the open. There's nothing like a short covering rally that starts before the open on expiration Friday. Traders were scrambling to hedge and covered positions right after the opening bell. Next week will be critical. We have just poked through formidable resistance at SPY 138. The next major resistance level is SPY 144. That price point should hold for the time being. It represents the five year up trend that was broken in January, the 200-day moving average, and the horizontal resistance line that dates back to the breakout a year ago. Without question, the bid is back. Here is an interesting scenario that could play out next week. The market is now discounting the probability for a .25% rate cut during next week's FOMC meeting. Those expectations continue to fall and it is possible that by the time they release their decision, the expectations will be even lower. The Fed will already know the unemployment number that is due to be released next Friday. If the Fed does not lower rates, the market will pull back. I believe that dip will present a buying opportunity. A weak Unemployment Report could translate into another round of credit problems and the Fed would not take that risk by keeping rates at their current level. Given the last three weeks of initial jobless claims, the unemployment rate could stabilize. If the employment picture improves, we could see a nice breakout and SPY 144 could be tested (with more good earnings). Banks have been able to secure capital and they have not relied on the Fed’s outstretched hand. The Fed’s special auctions have been under subscribed. This morning, the dollar is rallying against other major currencies. It's hard not to get excited when you see big rallies after months of gloom and doom. Try to temper your emotions and remember that we are not out of the woods yet. When this rally stalls, start scaling out of long positions. I still believe a “buy the dip” mentality is the way to go. image

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