This week, the market has been searching for direction. Volumes have declined and the activity has a pre-holiday feel to it. The European summit will drive prices today.
Eurocrats have been downplaying the summit to temper investor expectations. Solutions will be discussed but there will not be any landmark decisions.
The primary concern is Spanish yields. They have climbed to perilous levels and the EU is considering bond purchases through the EFSF. Spain is five times the size of Greece and a credit crisis of this magnitude would be devastating.
Eurocrats are considering a centralized banking system. Sovereigns would relinquish control over national banks and the ECB would be the primary regulator. This would be a meaningful first step, but it will take a year (or more) to implement.
Germany has been clear. Fiscal spending needs to be controlled before any pooling is considered. Strong countries don’t want joint liability unless they can be assured that reckless spending my weak countries ceases. These negotiations will continue into perpetuity and EU members will never agree to a universal fiscal policy.
The EU will continue to put Band-Aids on the problem. Next week, the ECB will meet. Many traders expect LTRO3. The Bank of England will also meet and the consensus is that they will institute a $50 billion round of quantitative easing. These events should be market friendly.
The Supreme Court upheld the health care program. This was largely expected by the market, but it is a bit disappointing.
This morning, GDP was in line and initial claims declined slightly. The big economic news will come next week (PMI’s, ISM’s, ADP, initial claims and the Unemployment Report). The Fourth of July holiday will bisect the action. China’s PMI is likely to fall below 50 (economic contraction) and job growth will decline (initial claims have been rising).
Stocks tend to rally into major holidays and I believe the market will find support. The releases on Thursday and Friday will strip away those gains and the SPY will test $130. That is a major horizontal support level and it is the 200-day moving average.
Earnings season is right around the corner and that should attract bargain hunters. Expectations are low and the strongest companies announced early in the cycle. Stocks will bounce off of support and they will challenge SPY $136. That is a major horizontal resistance level and it is the 100-day moving average.
I believe that an excellent put credit spreading opportunity lies ahead. I will be selling out of the money put credit spreads during the next few days. I will get a little breathing room early next week and then I will take a little heat after the economic releases on Thursday and Friday. Once that wave of selling passes, I believe the market will rebound.
I will be keeping my put credit spreads relatively small. This strategy will benefit from time decay and a decline in implied volatility. Interest rates are at historic lows and Asset Managers will bargain-hunt. Once the earnings rally runs its course, a fantastic opportunity will present itself.
I believe the market is on the verge of a substantial decline. It will begin in about three weeks. Germany’s Prime Minister will not be extending her presence at the current European summit. That shows a lack of urgency. Eurocrats will disappear on vacation and credit conditions will deteriorate. Corporate guidance will be weak and economic activity will decline.
I am focusing on the decline in 3 weeks. My put credit spreads will keep enough trouble while I wait for the set up.
The Supreme Court decision was disappointing, but we should get positive rhetoric out of Europe. The market should move higher for a few days and then it will decline for a few days. Earnings season begins July 10th and we should see a round of buying after next week.
Keep your powder relatively dry for a few weeks and wait for that selloff.