Last week the market broke key support levels after the Fed Chairman moved up the tapering timeline. Traders were expecting a softer tone and good news was priced in. As I mentioned last week, any surprise favored the downside. Quadruple witching added to the excitement and the selloff continues this morning.
The SPY is below the 100-day moving average and it is below the breakout level at $159. Significant technical damage has been done and Asset Managers will wait for signs of support. An intraday reversal will mark the low-end of the trading range and that low should hold the rest of the summer.
I took a small call position last Friday and I will add when I see that reversal. I believe we are close. The market is below the 20-day Bollinger Band (two standard deviations) and it will bounce. If the market closes back above the 100-day moving average I will buy more calls. We are a long ways off from that now and it will take a significant rally to get us back above $158.
Economic conditions have been sluggish for months. Activity is relatively stable. Europe is in dismal shape, but the flash PMI last week was a little better than expected. US growth will be hampered by the sequester, but the Fed sees growth on the horizon. China’s activity has been slipping. That is a concern, but they are still growing at a rate of 7.7%. Their market was down 5% overnight and the PBOC does not plan to stimulate – yet.
Stocks got ahead of themselves after a 25% rally in 12 months. We were overdue for a correction and traders don’t like the idea of having the punch bowl removed. If we have growth, the market will rally.
That is the current problem. Asset Managers are selling bonds to get ahead of the curve and yields are rising in the absence of economic growth. It will take a few months for the economy to get back on its feet and this decline will present a buying opportunity.
Long-term rallies like we’ve seen in the last year die hard. Short covering bounces can be very painful and they appear out of nowhere. All you need is a few “friendly” comments from a central bank and the squeeze is on. If you own puts – use stops and be ready to take profits.
The Fed will only taper when economic conditions improve. The silver lining was lost in the shuffle and Fed Officials are encouraged that the market has been able to maintain growth during the initial stages of the sequester.
Stock valuations are attractive and if interest rates start to rise, money will rotate out of fixed income and into equities. Corporate cash flows are at record levels and balance sheets are strong. Companies are buying back shares and Asset Managers are still looking to get in. I believe this dip will soon find support.
The economic news is fairly light this week (durable goods orders, initial claims and GDP). Next week we will get the official PMI’s, Chicago PMI, ISM manufacturing, ISM services, ADP and the Unemployment Report. It will be an abbreviated week because of the Fourth of July and the action will be swift. I believe the news will be better than feared and the market will bounce.
The farther we fall today, the better. We want to see capitulation and a sharp rebound off of the low. Asset Managers nibbled on Friday, but we obviously have more work to do on the downside. Once that low is established, buyers will rush back in.
I still expect a trading range this summer. The rebound should get us back into the middle of the range. We won’t get a sustained rally until we see economic improvement.
Option implied volatilities are on the rise and for the first time this year, put credit spreads are attractive. Look for strong stocks that have maintained the uptrend. When the market stages that intraday reversal, sell put credit spreads that are one or two strikes out of the money and make sure there is a support level above the strike price. If that support level is breached, buy back the spread.
This falling knife has not hit the floor. Be patient – I believe we are close.