An important part of making investment choices is to understand the context for the market and our current position in the long term economic cycle.
This is a discussion of my view of the US stock market today and its potential short-term direction. Today I will focus on recent market developments, including a look at the S&P500 (SPX) and its Volatility Index (VIX). My short-term view is that the market will remain stagnant to bullish in the short-term. A pullback, if it does occur, still represents a buying opportunity (see last Market View post on Mar 23, 2012).
Before I begin my commentary, I want to emphasize that my ability to make money is not entirely riding on my thesis being correct. In the OptionsANIMAL Methodology, we do not simply rely on our expectations coming true. Rather we develop an exit plan detailing how we will use options to work with our trades if they do go against us. Having this exit plan allows us to maintain emotional control and turn most losing trades into winners or breakeven by making trade adjustments.
S&P500 (SPX) closed at 1,397 on Mar 23rd, the last blog post in this series. My previous prediction was that the market will be stagnant to slightly bullish and any pullback will represent a buying opportunity. Presently SPX is at 1,411 or up about 1% and the small pullback we had looks to have been a buying opportunity. Indeed, the Dow Jones Industrial Average (INDU) just hit new 2012 highs this morning.
So why is this market ‘ignoring’
- Spain, with 10-yr bond yields briefly climbing above 6% in April and still elevated today at 5.73
- Weekly initial claims, which have come in poorer than expected most of Apr
- GDP, which came in lower than consensus at 2.2%
- EU, with Spain and their banks getting downgrades and slipping into a double dip recession
The main driver of the current bullishness in US equities is the better than expected earnings season. More than 70% of SPX stocks that have reported so far beat analyst estimates. There is also a continued focus on dividends and stock buy-backs as companies are flush with cash and still lean coming out of the recession. Stock buy-backs maybe part of the higher EPS in recent quarters. But the fact remains that the overall economic growth and labor market conditions continue to move in the right direction, all with tolerable, even favorable, inflation.
In addition, emerging markets have not performed well. Treasury yields don’t even cover the cost of inflation. Where else but the US equity market can investors find a good return?
There are signs of underlying bullish sentiment everywhere. China may actually be re-accelerating with manufacturing and inflation bouncing up recently after previous well publicized declines. When the US GDP number came in weaker than expected, the market rallied on hope that Father Fed will come to the rescue. If things are so bad in Europe, maybe there will be another LTRO package from the ECB to bolster and shield EU banks. EU Banks are getting money at 1% from the ECB that they are re-investing in high-yielding government bonds…what a nice scheme! Bottomline…the market is shrugging off bad news, a reliable sign of bullish sentiment.
The major fear indicator CBOE Volatility Index for S&P500 (VIX) is confirming this sentiment. VIX has held below 20 for the better part of 2012, down almost 6% just today. VIX readings of 50 or higher denote panic, 30-35 denotes fear and anxiety, 20 denotes nervousness and below 20 denotes complacency.
Technical support for the SPX is 1340-1360. We have to see if there is enough momentum now to break through resistance of around 1420-1425. This level is the previous resistance from March and the upper Bollinger band. We are gaining distance from the 50-day Simple Moving Average (SMA) on the SPX daily charts, but with the RSI at 60 today we are far from overbought just yet.
All this adds up to a cautiously bullish short term view of the market. I think the market may rise to 1440-1460 before the next pullback. I am positioned with a bullish bias in my portfolio today. If things start to deteriorate on new news, I am in a position to use options to start adding more hedges to my portfolio. I will also look to initiate additional bearish trades to take advantage of the decline, like I did last month on Groupon (GRPN).
Trade well and prosper, see you in the next blog post!