China’s Economic Releases Not Disastrous. Relief Rally Turns Into Earnings Rally Next Week.

July 13, 2012

Yesterday, the market tested the downside and it found support. The price action has been nasty this week and I suspected a rough patch ahead of China’s economic releases. Worst case scenarios were priced in and the results were not disastrous. Stocks are rebounding this morning and we should see a nice rally into next week.

China’s GDP growth slowed to 7.6%. That is slightly below estimates and it is the first time in three years that it has dipped below 8%. Industrial production was slightly below estimates (9.5%), retail sales were better than expected (13.7%) and fixed investments were a bit better (20.4%). Stocks in Asia rallied on the news.

The PBOC’s first objective is to keep inflation low. This week the CPI came in at 2.2%, the lowest level in many years. That means the road is paved for further easing and we could see two rate cuts and three reductions in bank reserve requirements this year. The PBOC has taken action and that will provide a backstop for the market. Furthermore, China will begin a fiscal spending program that builds out its infrastructure.

Moody’s downgraded Italy’s debt by two notches last night. Surprisingly, that did not impact their bond auction. They sold €3.5 billion in bonds and that was the top end of its range. Yields came in at 4.65% and that was better than the 5.3% yield in May. European interest rates have temporarily stabilized and that will allow traders to focus on earnings releases.

J.P. Morgan and Wells Fargo posted results this morning. Both stocks are trading higher after the release. The silver lining is that home loans are increasing. Wells Fargo processes one out of every three loans and they cited a recovery. Real estate is essential to a sustained economic recovery. From 2001 to 2005, 50% of our job growth came from the housing boom.

Tech stocks have been beaten down. Next week, Intel, IBM, eBay, QUALCOMM, Microsoft and Google will post results. These are some of the strongest companies and I believe the results will be decent. Shorts will not aggressively sell into rallies until earnings have been posted. That means we should see a rally during the next two weeks.

I believe bears got a little too aggressive and we could see short covering. The SPY will rally back above $136 before the momentum stalls.

Central banks around the world (ECB, BOE, PBOC, BOJ, Korea and Brazil) have all eased in the last week. That is bullish for equities and it is not wise to stand in the way of this force.

I sold some put spreads yesterday and I sold a few earlier in the week. My risk exposure is relatively small and I am just trying to generate a little income while I wait for this wave of buying to pass.

The rally this morning should continue throughout the day. I am expecting stocks to move higher next week. I still like selling out of the money put credit spreads so that I can distance myself from the action. My bearish forecast will keep me from getting too aggressive during this rally.

I’m proud of myself. I had to fight off temptation this week. I forecasted a pullback, but I knew it was a trap. If you were short, I hope you took my advice yesterday to take profits.

Aggressive accounts that have their finger on the trigger can consider buying a few calls today. I like companies that generate most of their revenue in the US. They include homebuilding, retail, restaurant, health care and tech.

Once this rally runs its course we will be set up for a nasty decline.
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