The Market Bid Has Weakened. 3 Puzzle Pieces Are A Bit Loose. Wait For Bank Earnings Fri

April 8, 2013

The market is still within striking distance of the all-time high, but my forecast has changed. There are three major puzzle pieces that need to remain intact in order for us to break out and follow-through. Each of the pieces is loose and the market bid has weakened.

The first puzzle piece has to do with European credit concerns. This is the most ominous dark cloud and it weighed our market during most of 2012. Italy does not have a governing party and they might need to hold another election. This will be resolved in a month or two. Banks in Cyprus reopened and that issue is behind us. PIIGS yields are stable, but that can change quickly. Economic conditions in the EU are dismal and the deficits are huge.

China is the second puzzle piece. It is the growth engine for the world. Their PMI came in light last month and the PBOC has been tightening (removing liquidity and imposing real estate restrictions). They are still on track to grow 8% this year, but their market is challenging support at the 200-day moving average. A recent outbreak of bird flu could impact economic activity and tourism.

The third puzzle piece is gradual economic growth in the US. Last week’s jobs report was horrible. ISM services ISM manufacturing also came in light. We needed a full head of steam heading into spending cuts (sequester) and we don’t have it. A year ago, our economy hit a soft patch in April and traders are willing to give the recent releases a “free pass”. If this continues in May, the market will decline.

If all of these puzzle pieces were securely in place, the market would be making a new all-time high. Asset Managers who have been waiting for a 5% pullback would get nervous into earnings season and they would aggressively bid for stocks. That is no longer the case. The recent economic releases will provide breathing room and they will wait for more evidence.

Alcoa will post results after the close today. Basic materials stocks have been pounded and demand is low. There might be room for a small bounce, but the move will be brief. Their guidance will be back-loaded in 2013. The expectations are low so this news should not dampened spirits too much.

Friday, J.P. Morgan and Wells Fargo will post results. Bank profits should be strong and financials need to lead the rally. I will wait for that reaction before I get long.

In general, Q1 revenues will be flat and profit margins will be healthy. Cash flows will hit record levels and balance sheets will be stronger than ever. At a forward P/E of 14, stocks are attractive relative to bonds. If all of the other puzzle pieces were firmly in place the market would grind higher. There simply aren’t any better investment alternatives.

Now that the landscape is changed, I believe the market will test support at SPY 153. I expect that level to hold and I will buy calls when it does. A soft initial jobless claims number this Thursday could be the event that tests that support.

Earnings will be decent and the market will bounce. We will challenge the all-time high, but I am not expecting much of a breakout. There are too many uncertainties and the bid has weakened. That means the dips will be a little deeper and they will last a little longer.

I reduced my call position to 25% last Friday and I am getting out completely today. I still have an overall profit in the last month and I want to reset. I’ve had some of my positions on for a few weeks and I want to start with a clean slate.

I plan on day trading this week and I feel that there will be opportunities on both sides. I want to see how the market reacts to bank earnings. I expect them to be strong and I want to see a rally in the financial sector with follow through.

I am not bearish. I am also not is bullish as I was two weeks ago. The recent round of economic news (especially in the US) was concerning.

Try to lighten up on bullish positions and if possible, go to the sidelines. There will be an opportunity to get long at a better price level and we will be armed with more information.
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