Never Short A Quiet Market. Look For Light Volume and An Upward Bias.

August 14, 2012

Did someone forget to ring the opening bell? The S&P 500 futures have had a one point range in the first hour of trading. As I mentioned yesterday, a slow week lies ahead.

Earnings season is winding down and we won’t have any major economic releases this week. European credit concerns have temporarily been pacified. This means stocks should be able to quietly march higher this week.

Revenues were light this quarter, but corporations are running lean and mean. They were able to preserve profits through cost-cutting and valuations are attractive. With bond yields at historic lows, Asset Managers are anxious to rotate out of fixed income and into equities. They see dark storm clouds ahead and they won’t chase.

Economic activity is better than feared, but it is not robust. Even if the numbers come in soft, traders believe that central banks will ease. This is backstopping the market and we are not likely to see a major decline in the next week or two.

The ECB did not provide any details to back up statements by Draghi. They will provide assistance to countries that have cut fiscal spending. Short-term bond auctions will be supported and that will reduce short-term borrowing costs. By no means is this a long-term solution. For now, the market is satisfied.

Eurocrats are also promising that plans for a centralized banking system will be drafted by the end of September. Again, traders are embracing the idea and they won’t get anxious for another month. These little Band-Aids and false promises will support the market temporarily.

Long-term interest rates in Italy and Spain have declined. They are still within striking distance of the highs and conditions can change instantly. Combined, they represent 20% of the EU’s GDP. The stakes have never been higher and EU has to stay ahead of the curve. If they fall behind now, the market will not be forgiving.

China still has quite a bit of latitude for easing. However, that is not the case in Europe or the US. We are almost out of bullets and previous actions have not stimulated economic activity. The Fed is holding off on QE3 and it knows the market will be looking for its next “fix” as soon as it is announced.

This market rally will lull you to sleep. Stocks keep grinding higher and everything feels great.

Europeans will muddle around and the market will grow impatient. Economic conditions will be soft and traders will wonder if easing will stimulate growth. The November elections will divide our country and the fiscal cliff will draw near. I still believe that the risk of a nasty decline is high.

Bullish speculators will get sucked in and the market could make a new multi-year high in coming weeks. Once that momentum stalls, beware.

Option implied volatilities are near historic lows and that means no one is looking for a selloff. Economic conditions are tenuous and nothing in Europe has been solved.

I am day trading stocks from the long side. I like setups where the underlying is in an uptrend and it has consolidated in a tight range the last few months. Now, it is breaking out to new relative high.

Home Depot is a classic example. I am not saying to rush into HD; I am just trying to give you an example of the chart pattern I am looking for. These patterns tend to result in a sustained move for at least a day or two and they will fare well in a quiet market.

I am keeping my overnight risk exposure very low.

The only thing that could change my mind is decisive action by the EU/ECB. I’m not talking about promises; I am talking about a detailed plan that results in universal approval. The probability of this taking place in 2012 is less than 10%.

Trade the long side this week and keep your stops tight. Resistance at SPY $142 is formidable and a breakout above SPY $142 would spark buying. Once that momentum dies, get out.

Look for a gradual grind higher on light volume this week.
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August 13, 2012

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