Before the open yesterday, the rally looked very suspicious. Italian elections were still up in the air and China posted a weaker than expected flash PMI. Once the market gains were erased, the downward momentum was established. Asset Managers pulled bids and bullish speculators bailed. The last 100 Dow points came late in the day on light volume and that is what I call an “air pocket”.
European credit concerns have been declining for months and in a matter of hours everything changed. Italian bond yields were up 28 basis points after the election results were known. This reaction was overblown and Italy will be nothing more than a blip on the radar in a few weeks.
Berlusconi did better than expected in the polls, but he will not unravel the EU. The ECB is printing money like mad and the EU agreed to a centralized banking authority. Credit concerns in Europe will come back to haunt us, but it won’t be because of this election. It will take time for fear to escalate.
I would be much more concerned if I saw a gradual rise in PIIGS yields without any news. That would tell me that bondholders are liquidating and that they see trouble on the horizon. I constantly monitor PIIGs auctions and the results will give me fair warning.
China’s flash PMI is a bigger issue. The official number will come out Thursday evening. The PBOC has removed liquidity and the government wants to restrict real estate speculation. China posted worse than expected retail sales and this recent decline in activity could be problematic. We need to see continued growth in China.
This morning, Ben Benanke will testify before Congress. I believe his comments will be market friendly and we will get a relief rally. The sequestration will reduce growth and the Fed stay accommodative for a long time. When they stop purchasing U.S. Treasuries, they will carry a large balance sheet. They won’t unwind until they are certain that economic conditions are improving. I expect this to come out in his testimony today.
The sequestration will happen and the political banter has become ugly. Investors were comfortable with the idea a week ago and I don’t believe that sentiment has changed. We need to curb deficit spending and if the economy can grow slowly on its own, it would be bullish on a longer-term basis.
Chicago PMI will be released Thursday and ISM manufacturing will be released on Friday. These numbers will impact the market. Empire Manufacturing was better than expected last week and the Philly Fed was worse than expected. We need more data points. The jobs numbers next week will also be very important.
Retailers are dominating the earnings scene this week. The expectations are low and Q4 has been decent. Unfortunately, guidance is dismal. Payroll tax hikes and record gasoline prices in the month of February are weighing on consumption. The earnings news will have a negative market impact.
As I’ve been saying, the market needs time. There will be reasons to buy and reasons to sell. I believe we will quickly establish a support level and SPY 148 should hold. If it does not, major support is at 145. The trading range will be SPY 145 – 153 and the market will chop around for a few weeks.
Economic growth is the key. We need to see improving conditions in China and in the US. If we are truly coming out of a trough, analysts will raise Q1 earnings estimates and Asset Managers will buy stocks ahead of releases in April.
Fed speak should be market friendly today and I believe the S&P 500 will recover at least 10 points by the end of the day. The sequester and retail earnings will soften things up towards the end of the week and we will drift lower. After the employment reports next week, the market should establish support.
I don’t want to discount yesterday’s decline. That was a nasty reversal and bullish speculators needed to get flushed out. From a six-week time horizon, it was a normal correction. It was momentum driven and it came on light volume. I want to buy this dip, but I will wait for support.
Until then, I am day trading. If the market is above one hour range, I am buying strong stocks. If it is below its one-hour range I am looking for shorting opportunities. I am avoiding overnight risk.
If the economic releases are stable and the market finds support next week, I will start scaling into call positions.
Look for a bounce today.