Bulls Will Not Buy Ahead of China’s Releases. Choppy Action On Light Volume This Week.

July 10, 2012

Yesterday, the market tested the downside after Friday’s decline. Support was established early and buyers stepped in. By the close losses were negligible.

Earnings season has officially kicked off. Alcoa beat by a penny and it still projects an aluminum supply deficit in 2012. It reaffirmed its forecast that global aluminum demand would grow 7% this year. The stock is down slightly after the release.

Advanced Micro Devices warned. The company has been struggling for years and tech stocks are holding up after the news.

European yields have pulled back slightly overnight. Spanish banks will get €30 billion in aid by the end of the month. Spain is also going to announce a plan in a few days that will give provinces access to credit at lower rates. This is just lip service since the government and banks are tapped out.

Conditions in Europe are extremely tenuous. They will lead to a massive market decline later this summer. For now, blank Euro promises will calm nerves and traders will focus on earnings.

J.P. Morgan and Wells Fargo will post results on Friday. Apart from the massive trading losses, JPM’s results should be good. These are two of the strongest banks in the country and they will set the tone for the financial sector. Intel, eBay, IBM, QUALCOMM, and Microsoft will post results next week. These companies have a history of beating expectations and bears will not aggressively short ahead of these announcements.

Stocks typically rally during the first two weeks of earnings season. The strongest companies post results early in the cycle and optimism builds quickly.

The economic releases are light this week. China will release industrial production, retail sales, new loans and GDP Thursday evening. This is the biggest event of the week. Many analysts feel that GDP will fall to 7.2%, but the consensus is at 7.8%. Q1 GDP was 8.1% and given recent releases, there is no question that growth is slowing.

Even if the numbers come in soft, the downside will be relatively contained. CPI came in at 2.2%, the lowest level in years. Inflation is the PBOC’s primary focus and the decline will pave the way for future easing.

Last week, China lowered interest rates for the second time in a month. Investors might not like the economic releases, but they will take comfort knowing that the PBOC is prepared to take action. Once we get through this news, the market should be able to grind higher.

Interest rates are at historic lows and Asset Managers will bargain hunt. Corporate balance sheets are rock solid and stock valuations are attractive (forward P/E of 13 on the S&P 500). Earnings season is the best thing the market has going for it. If it can’t rally now, we are in big trouble.

This wave of buying should push the SPY back above $136. The momentum will stall in a couple of weeks and shorts will regain their confidence. Pre-announcement warnings are higher than they were in Q1 and guidance will be very cautious. Corporations are faced with uncertainty (European credit concerns, declining economic activity in China, a national healthcare program, the November elections and the fiscal cliff in January).

Eurocrats will vacation in Club Med (a.k.a. Portugal, Italy, Greece and Spain) and credit concerns will build when no one is “minding the shop”. We have seen this pattern the last two summers and the table is set for a repeat performance.

Employment conditions are deteriorating and the presidential race is tightening. The market will start a nasty decline towards the end of July.

I am “gnawing at the bit” to short this market, but I know it’s too early. To keep myself busy and to keep myself from doing something stupid, I am selling out of the money July put credit spreads. I will keep my size small and I will take advantage of the mini-rally that should gain traction towards the end of the week. If the market can’t hold SPY $130, I will buy back my short put positions and ride the long puts. I will also buy more puts. That is a major support level.

Minor support at SPY $134 should hold this week and we should rally next week. The action is choppy today and there is still some nervousness ahead of China’s economic releases. Bears don’t want to short ahead of earnings season and bulls don’t want to buy ahead of China’s economic releases. Look for light volume and directionless trading this week.
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