Lows From Monday Breached. Market Will Probe For Support – SPY 153 Should Hold

April 18, 2013

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This week we are starting to see some cracks in the dam. The market sold off Monday and the relief rally on Tuesday came on light volume. Wednesday, stocks retreated and the low from Monday has been breached. This is bearish price action and it could be signaling a short term market top.

Global economic conditions are deteriorating. China’s industrial production, retail sales and GDP all missed estimates. The PBOC has been tightening and the government does not have any immediate stimulus plans. China’s market breached the 200-day moving average this week and flash PMI’s will be released next week. This could be the next speed bump for the market.

Domestic economic releases have been soft as well. The Unemployment Report, ADP, initial claims, ISM services, ISM manufacturing, Empire Manufacturing and the Beige Book all pointed to slower growth. This morning, initial claims rose by 2,000 and the Philly Fed came in below expectations. This soft patch is concerning because we needed to have a full head of steam before the fiscal spending cuts take effect in May.

European credit concerns remain subdued and overnight bond auctions went well. However, this can change quickly. Cyprus still needs to raise money for its banks and Italy does not have a governing party. Economic conditions across the EU are dire and weakness is spreading to core countries. Tax revenues are down and deficits are growing. In 2011 and 2012, European credit concerns flared up in May.

Earnings season is in full bloom. Revenues are flat and profit margins are healthy. Cash flows are hitting record levels and balance sheets have never been stronger. US equities remain attractive due to a lack of investment alternatives. If global economic conditions were stable, our market would push higher.

In March, global activity was strong and Asset Managers were worried. They were waiting for a pullback and they never got one. Stocks inched higher and Asset Managers feared that they would miss the next big rally. The bid was strong and they were buying every dip. This has changed in the last two weeks.

As soon as China’s PMI came in weak (end of March) Asset Managers knew they had some breathing room. Then, US jobs reports missed expectations. This combination severely weakened the bid and now Asset Managers are waiting for evidence that an economic recovery is underway.

A few weeks ago, profit taking was met with strong demand. The market never stumbled because buyers were close at hand. That is no longer the case.

Monday’s decline was followed by the light volume relief rally and the lows from that sell-off were tested immediately. Profit takers are scrambling to hit bids and Asset Managers are passive. They don’t want to chase stocks near an all-time high and they are pulling bids.

I still believe it is too early to short this market. China’s flash PMI will spark fear and the SPY will test significant support at $153 next week. The numbers will be soft, but better than feared. A decent round of earnings releases will result in a small rally. It will run out of steam before we reach the all-time high and the market will make a lower high. That formation will signal heavy resistance and a short term market top.

As we head into May, SPY 153 will be tested and that support level could fail if global economic conditions continue to deteriorate.

It is tough to predict every wiggle and jiggle when there are so many variables. Here is how I plan to trade the next few weeks.

I am currently day trading and I am keeping my overnight risk exposure very low. I have been able to catch every major move without taking much risk. If the market falls to SPY $153 and it finds support, I will buy calls on stocks that belong to the strongest sectors. I will stop those positions out if SPY $153 fails. I don’t plan on instantly flipping to a bearish bias. The market has been strong uptrend and I need concrete evidence that the reversal is underway.

My bias has changed from bullish to neutral. I still believe there is room for a nice little earnings rally off of support at SPY 153. I will keep my size small knowing that conditions have changed.

For today, the market wants to head lower. The lows of the week have been breached and we will probe for support.
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