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Contrary to my opinion, the equity markets opened the week with a massive rally which took the SPX well above the 900 level. The market internals were one of the most bullish I have seen in a long time; the A/D ratio was at 12.75:1 on the NYSE and 3.88:1 on the Nasdaq. The small cap Russell 2000 outpaced all other indices, up 3.35% and showing that risk appetite was back with a vengeance.

The rally was led by financial and real estate stocks, especially Bank of America (NYSE:BAC). The bullish news from the Indian stock markets, where the circuit breakers were hit on the upside, seems to have helped improve sentiment, with CNBC reporting that traders on the NYSE were also acknowledging the fact.

The Capital Raising Shenanigans Continue

Citigroup (NYSE:C) reported that that BAC may have raised $4B in new capital by selling equity in the open market. As if on a cue, Goldman Sachs (NYSE:GS) placed BAC on their conviction buy list. To complete the bull parade, Dick Bove, an analyst respected by the Street came out with very positive recommendations on financial stocks, including a $48 price target on BAC in five years (4x returns). The news that Goldman Sachs, JPMorgan (NYSE:JPM) and Morgan Stanley (NYSE:MS) will likely return TARP funds help improve the sentiment.

I was hoping that the capital-raises by the banks, and support the market shenanigans that went with it were done after the Stress Tests. But clearly I was wrong. Unlike Meredith Whitney, Dick Bove has been bullish on banks stocks throughout the decimation they endured during the past 18 months. However, he is still able to add fuel to the fire sparked by Goldman.

Real Estate Joins the Party

Another factor contributing to the rally was the usual better than expected results from Lowe’s (NYSE:LOW), which was peppered with some positive comments about high margins sales of potted plants and patio furniture. The home-maker’s Housing Market Index showed a 2 point improvement from April, primarily driven by optimism among home-makers themselves that the current and future sales will improve while the customer traffic component was flat. This led to a big rally in the homebuilders (NYSEARCA:XHB).

My Portfolio

The stock market typically rallies in the options expiry week and then corrects in the week after. This month the action was reversed, with the stock market testing key levels during the Options expiration week, and then rallying strongly the next Monday.

The stocks I was waiting to buy on a pullback (OIH, GDX) did not come to the levels I was comfortable buying at. As a result, I did not open any new long positions, but day-traded index futures.

IYR Puts

A rising tide lifts all boats, and even the commercial REITs rallied hard, with the IYR up 7.5%. More importantly, the charts of many of IYR components which were on the verge of a technical breakdown, seemed to have stepped back from the edge of a cliff.

As I have noted earlier, the IYR has been an excellent trading vehicle, often seeing 5-10% movements within a day or two. I have been trading IYR puts; buying them on major rally, and selling them on a decline. I added to my IYR put position Monday.

click to enlarge

IYR Channel

IYR is challenging the lower trend-line of the channel it fell out off again. My expectation is that it will fail at this trend line and pull back. The wild-card of course is the chance that another REIT lines up with a secondary offering resulting in the street providing support to the sector. Luckily, the June expiration cycle is very long (5 weeks) leaving ample time for IYR to correct and the puts to make a profit.

Treasury Bonds: TLT Decision Pays Off

Last Friday, I had decided to wind-up my long position on the TLT by not rolling over in the money call options, and allowing my stock to be called out. On Monday the spread between the TYX and TNX (30Year and 10Year yield) further widened by 2 bps to 97 basis points. The TLT fell by $1.52, as risk appetite returned and treasuries were sold.

Oil Services Rally

I had been waiting for the OIH to pull back a bit more before I enter a long position, however, I did not get a chance as it rallied closed to 5% Monday. OIH continues to be in a downward channel so I am not going to chase this rally.

Closing Note

I do understand the thesis that the bank’s regular lending business is very profitable now. However, the questions about the assets formerly known as toxic assets (aka legacy assets) still remain. But it seems that the establishment (the government and Wall Street) wants the investing public to forget about them and instead focus on the positives.

As an American I do want our financial system to heal and the recession to end. But I get scared when the establishment uses its power to control information flow and sway investor sentiment.

Source: Monday Market Review: Bulls Back with a Vengence