Last week we finally saw some two-sided action. There were reasons to buy and sell, but at the end of the week the market finished where it started. This is exactly the type of trading pattern I expect to see over the next few weeks. After a nice run, stocks need time to consolidate.
The macro backdrop is still long-term bullish, but there are a few speed bumps that stand in our way this week. The flash PMI’s were not very good. Europe missed by a large margin and last night we learned that China missed as well. Growth in China is a critical piece of the macro picture and conditions need to improve over the next few weeks. The PBOC has removed liquidity and that is also a minor concern.
Wednesday, Ben Bernanke will testify before Congress. Traders will be looking for a timeline. Sooner or later, they will have to stop quantitative easing. I believe his comments will be “market friendly”.
The sequester will weigh on economic activity and the Fed wants to evaluate the full impact before they make any statements. Furthermore, just because The Fed stops purchasing US Treasuries, it doesn’t mean they have to unwind current positions. They can maintain a large balance sheet until they see economic improvement.
This week retailers will post results. Wal-Mart set the tone last week and Q1 guidance will be critical. The largest retailer in the world expects flat same-store sales in the first quarter and it blames payroll taxes and high gasoline prices. These earnings releases could also weigh on the market.
Throughout the week, the political banter will escalate as we prepare for the sequester. The comments will get ugly and the market won’t like it. That weakness will be temporary.
Investors seem content with the spending cuts happen. A reduction in deficit spending would be long-term bullish for the market.
Here is the bottom line. European credit concerns are low and growth in China should eclipse 8% this year. Economic conditions in the US are stable and employment is gradually improving. Corporate profits have been good and 73% of the releases have exceeded earnings estimates. Stocks are trading at a forward P/E of 14 and they are attractively valued relative to bonds.
Asset Managers want to buy, but they won’t chase at this level without a reason. They need to see how the sequester plays out and they need to see improving economic conditions. If we are truly coming out of the trough, analysts will raise earnings guidance and the bid will strengthen.
If we hit another air pocket, support at SPY 148 should hold. Last week’s selloff came on light volume and Asset Managers simply pulled bids. Any decline will be brief and shallow as long as economic conditions muddle along.
The price action will be very choppy this week. We should see a relief rally after Fed Speak on Wednesday and those gains will evaporate Friday when the sequester is initiated.
I am day trading based on the first hour range of the SPY. If we are above the high I am looking are strong stocks. If we are below the low, I am looking for shorting opportunities. In this noisy environment, I want to limit my overnight exposure.
We need to spend some time in a range. Keep your size small.