Manic Monday Market Outlook

by: Philip Davis

I love alliterative titles, don’t you?

Fun time is over, the Jets lost to the Colts (who avenged their first loss of the season) and the Saints beat the Vikings in overtime, actually putting the best two teams from each conference (by record) into the Superbowl for the first time in ages. Superbowl tickets are going for $2,800 (average according to Stub Hub), which is about the same as the last two years, so no economic downturn is being felt there.

As I mentioned in the weekend wrap-up, we were fortunate enough to have cashed out the bull side ahead of the holidays and we followed our two-step program for bearish success on Friday by 1) taking the money and 2) running - as it’s been a very long time since holding a bearish position over the weekend hasn’t been punished by the market gods (by that, of course, I mean Lloyd Blankfein).

We have plenty of bullish plays that we attempted to bottom fish last week (see our Weekly Wrap-Up and save money by buying our mistakes!) and we still have our disaster hedges in case things get worse but, on the whole, we’re expecting a 1% bounce in the very least off our 5% lines (anything less will be a bad sign) and our chart is shaping up like this (click to enlarge):

Clearly you can see why we have a 5% rule - that alignment on the US indexes on Friday is no coincidence. Our 5% rule tells us that we should EXPECT a 20% retrace of the drop at each 5% level so a 1% bounce here and a 2% bounce at 10% (if we fall that far) would still be considered signs of continuing weakness until they are broken over. Conveniently, today, we can just look for 1% gains on our major indexes but the levels we are shooting for as a retrace are: Dow 10,300, S&P 1,105, Nasdaq 2,225, NYSE 7,100 and Russell 625 and yes, those are not exactly 1% as we’re taking into account other resistances we chart including psychological resistance, which comes into play at Dow 10,300 and NYSE 7,100 so we round to those.

Both the Nikkei and the FTSE bounced off their 5% levels and both have been rejected off their 4% bounce level (the FTSE is still open, of course) but it’s the DAX that has something to prove as they have already blown 5% support and are not up 25% (also support) from their July base anymore so that’s 2 out of 3 strikes we can allow before pointing an ominous finger at that 10% line (a 40% retrace of the rise up - in line with Fibonacci expectations), which is the next stop if the market turns ugly.

Check out Michael Clark’s Global Chart Review if you haven’t already, he draws a great picture of the technical issues we’re facing; but I must say that this all cracks me up as we’re BUYING now, not selling. Yes, I’ve been bearish since Thanksgiving saying a big correction will come, A Big Correction Will Come, A BIG CORRECTION WILL COME and we just got the biggest one-week market correction since last February and I AM SATISFIED! I’m not saying we’re now going to fly back over 1,150 on the S&P tomorrow but I am satisfied that we finally got a pullback and tested the 10,200 line I’ve been wanting to see tested since we first broke through it in November. We did touch it for about 10 seconds on Nov 27th (Friday after Thanksgiving) but that was low-volume nonsense and not a proper test.

It was the manipulative moves that PREVENTED us from testing 10,200 that made me more and more insistent that we would get a drop and, next time, I will know better and wait to be at least 4% wrong before piling on the bearish bets - it would have saved a lot of hassle! Do not mistake this for BUYBUYBUY premise, I was SURE we would sell off but that was 5% ago - now we could bounce back - but it would be far better if we consolidate here or sell off a bit more with some volume to firmly establish 10,200 as a new support for the Dow -- otherwise, we’ll be looking at good old 9,650 on the Dow and 1,035 on the S&P and 2,100 on the Nasdaq, 6,660 on the NYSE and good old 585 on the Russell as our "must hold" levels, where we do feel good about the fundamental support.

Since THAT is our premise, we don’t mind bottom fishing a bit here with our buy/write strategy, especially when we are able to take advantage of the higher VIX to give ourselves a 15-20% discount on the positions we enter (see "How to Buy Stocks for a 15-20% Discount") - that will take us all the way back to our July base. That’s why you can see in the Wrap-Up that we took mostly buy/writes to work into new positions as well as some naked put selling for positions we are a little more worried about (because the put is a lower commitment and can be rolled even lower without having to commit to the position). The simple logic for our bargain hunting is this - if you regretted not buying stocks when the Dow was at 8,200 in July and we can scale into positions that break even on a 20% drop that protects us down to 8,200 - then why not take a chance on what may be the 2nd opportunity of a lifetime in 12 months?

We have our disaster hedges so we are well covered to the downside and balancing our portfolios means we WANT to identify bullish opportunities but we’re not going to be idiots about it. This is why it’s a good time to watch our levels and exercise caution but, as I said, the FTSE and the Nikkei both bounced off their 5% lines, and our futures make it seem like we should do the same so our job for this week is to hang loose and go with the flow and try not to force our plays one way or the other. We had 61 trade ideas last week (which is a lot in 4 days) and 27 of them are not winners yet as we tried to keep an even mix of bullish and bearish plays. Did Big Bad Barack scare little Goldman Sachs (NYSE:GS) and force them to pack up their bag of tricks and go home, or did we simply get a huge overreaction to some mild political backlash?

As I said to members in our Weekend Chat, the Supreme Court handed corporate America the largest gift in the history of the United States last week or, as the NY Times so rightly puts it: "With a single, disastrous 5-to-4 ruling, the Supreme Court has thrust politics back to the robber-baron era of the 19th century. Disingenuously waving the flag of the First Amendment, the court’s conservative majority has paved the way for corporations to use their vast treasuries to overwhelm elections and intimidate elected officials into doing their bidding." Hey it sucks for "them" but it’s good for "US!" WE (the top 10%, not we,The People in the bottom 90%) own those corporations and now we can go out and expense as many politicians as we need to get ourselves some good government. That’s why we bought Peabody Energy (BTU) last week - global warming is now an issue of the past!

So we now have a VERY positive long-term market story to latch onto but it is still earnings season and we have plenty of data including Existing Home Sales at 10 today, Case Shiller, Consumer Confidence and the Home Price Index tomorrow, a Fed Rate Decision on Wednesday, Jobs and Durable Goods orders on Thursday all leading up to a highly inflated Q4 GDP Report (at least 5% now expected) as bullish inventory builds and rising commodity prices gave our economy quite the apparent boost. If it comes in well and the market flies, we’ll probably sell into it and flip bearish, but let’s not get ahead of ourselves. Also on Friday is the Employment Cost Index (where we can celebrate paying "them" less!), the Chicago PMI (will be down despite our "amazing" GDP) and the Michigan Sentiment (who still lives in Michigan?).

We also have over 300 earnings reports, so nonstop fun but, for today, we will be seeing what happens and hoping we didn’t get too far ahead of ourselves in our early bottom fishing expedition last week.