Yesterday’s market decline was merely a speed bump. We want to see a nice orderly rally where stocks don’t get ahead of themselves and this was a nice little reprieve. The volume was light and buyers simply put their wallets back in their pockets. This morning, we’ve made back most of the losses.
Asset Managers wanted to gauge selling pressure. If they saw a heavy round profit-taking, they would wait for a better entry point. Now we know that the bid is strong and the market wants to move higher. We couldn’t even muster two days of selling.
Shorts are not going to stand in the way of this freight train. The S&P 500 just made a five-year high and it is within striking distance of the all-time high.
I mentioned yesterday that the news from Europe was not material. It should not come as a surprise that Spain has political corruption. Being from Chicago, I am numb to it. At the end of the day, hands get slapped and we go on our merry way. This news simply gave investors a reason to sell European stocks after a nice run.
Economic conditions in Europe are dismal, but they are improving. The EU agreed to form a centralized banking authority and that is a major accomplishment. The ECB continues to print money and PIIGS auctions have gone well. These pieces of the puzzle are still in place and credit risks are currently low.
Economic growth in China is strong. Analysts believe that growth will eclipse 8% this year. New leaders will keep their foot on the gas pedal.
Domestic economic releases have also been encouraging. Private sector job growth was strong in January and planned layoffs were down 25% year-over-year. This morning, ISM services came in at 55.2 (in line). The service sector accounts for 80% of our economic activity and this was a strong number.
Earnings season has been in line with expectations. We’ve heard from all of the major sectors and groups. Revenues are flat and earnings have been preserved through cost-cutting. Most analysts believe that we are coming out of an earnings trough and they are willing to discount current results.
Stocks are attractively valued at a forward P/E of 13. Bond yields are near historic lows and money is flowing out of fixed income and into equities. The level of fear is low as measured by option implied volatilities (VIX). Asset Managers are in “risk on” mode.
Everyone is looking to buy dips. That means they will be brief and shallow.
The headwinds will blow as we approach the all-time highs. If the rhetoric out of DC is “friendly”, the market will break out. The sequestration is a month away and we need to see coordinated spending cuts. The market will give politicians the benefit of the doubt and it should be able to rally for a few weeks.
The economic news is light this week and earnings announcements should not provide any surprises. Look for choppy trading with an upward bias.
I believe the rally today will hold, but I don’t believe we will climb this afternoon. Overnight earnings should be good and we will see a nice little pop in the morning.
Buy calls. Look for stocks that are breaking through horizontal resistance on strong volume. Hold these positions until the momentum stalls and then take profits. Repeat.