Draghi Plays It Close To the Vest – Market Satisfied. ADP Beats Estimates. Rally Should Have Legs

September 6, 2012

This morning the market broke out to new four-year highs. Comments from Draghi were general and traders didn’t care. ADP and initial claims exceeded expectations and the combination of events sparked buying.

Stocks have been in a tight trading range for an extended period of time. These breakouts tend to produce sustained moves. We’ve been waiting for some sense of direction and now we know which side to play.

Draghi said that they will support sovereign bond auctions as long as fiscal spending conditions are met. He did not mention the size of the program or target yields. In the early stages the market will assume that the ECB’s level of commitment is high. It needs to be, because they are the buyer of last resort. Over time, we will see if they can keep a lid on interest rates.

Countries still have to apply for aid and that could be a sticky point. Spain has not done so and it does not want to give up fiscal spending control. Rumor has it that Italy could be applying for a bailout by the end of the year. Countries that do not adhere to conditions (Greece) will be denied.

Structural deficits will drag PIIGS further and further into debt each year. Short-term bond auctions will go well initially, but the EFSF will be tested as deficits grow. This process could take a few months to unfold.

Initial jobless claims have been steady the last few weeks and they declined to 365,000 today. ADP reported that 201,000 new jobs were created in the private sector during the month of August. That was much better than expected and estimates for tomorrow’s Unemployment Report are moving higher. Additionally, ISM services improved to 53.7. The economic releases today were bullish.

Asset Managers are playing catch-up this morning and they want to make sure they don’t miss a year-end rally. As long as European credit concerns are pacified, the market will move higher.

China’s economic contraction will get a “free pass”. Even if conditions worsen, traders will expect action from the PBOC. I believe they are headed for a hard landing and interest rate cuts won’t stop the bleeding. This deterioration will also take a few months to play out.

The November elections and the fiscal cliff seem light-years away. Right now, traders are focusing on short term events.

I believe that the market will grind higher the next few days. Buy calls on stocks that are in an uptrend and have consolidated in a tight range. When they break out two new relative highs, take a position. This pattern produces sustained moves and you need to find stocks that have pent-up demand. I like tech more than any other sector. Commodity stocks are overdue for a bounce, but weakness in China will keep a lid on this group.

We have a breakout and my entry point for short positions has moved up. If the SPY closes below $142, I will buy puts. I don’t believe this will happen in the next week, but a reversal off of a new high could spark a swift move downward as bullish speculators get flushed out.

I liked the domestic economic news, but Draghi did not bring much to the table. The market will test his conviction in coming months and China’s economy will continue to slip. The news from FedEx was dismal and next week we will get a mid-quarter update from TXN.

Play the upside as long as the SPY stays above $142 and look for stocks that fit the pattern I just outlined.

I am exited my VXX/SPY call position at a small loss this morning on the breakout. This was a small position and now I will focus on bullish trades.
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