So the market has now crossed above the key 1280 resistance Level. While volatility has come down considerably, obviously, investor and trader pessimism remains at fairly elevated levels. Despite the improving economic news in the U.S. and easing over credit concerns in Europe, economic data from emerging markets, like China, has remained fairly weak. Given that even with the market's move above key resistance levels at 1280, we are still lower than where the market was just two years ago at 1370, it is worth asking where the best trading opportunity is for traders who think the market has upside from here.
The heart of the sell-off prior to the October rally was in both the European and U.S. financials. While, certainly, credit issues remain in Europe and housing prices are not rising on a national basis in the U.S., concerns over a major credit event in Europe or a need to recapitalize the banks in the U.S. has diminished significantly. Also, while most cyclical sectors are predictably leading a market rally that is primarily based on improving macro data, very few stocks are moving on company specific news. In an environment where macro data and economic news are generally causing stocks to move as an asset class, the financials should have the most upside as the market moves higher. Even as the S&P 500 (SPY) and most other broader market indexes rallied significantly in October, most of the financials continued to underperform or move up only modestly.
In addition to being the worst performing sectors last year, these stocks will be among the primary beneficiaries of both an improving economy in the U.S. and more cooperative environment in D.C. With Romney gaining steam, the tea party's influence being diminished by an effort by Republicans to moderate ahead of the election, and many of the enforceable provisions of Dodd-Frank still uncertain, the financials should be the sector that benefits most from a better environment in D.C. and an improving economy in the U.S. This sector is also likely the most under invested sector by most money managers as well.
So how would you get long these stocks? With volatility as low as it is I think the best way to trade these names is to use in the money call spreads. You can purchase the January 2013 Citigroup (C) call option at 20 dollars for 12 dollars, and sell the January 2013 45 dollar call option for 1 dollar, this trade gives you potential upside of 100%, limits your capital, and enables you to pay almost nothing in premium for the right to purchase Citigroup's shares at around 30 dollars a share.
While Citi does have exposure to the emerging markets, its exposure is fairly well spread out between India, China, and Latin America, and as the U.S. economy continues to recover, it is likely that the emerging markets will see their economies begin to pick up steam in the back half of the year as well. I detailed these and other points more specifically in my recent December article on Citigroup. The financials are the best positioned to benefit from both an improving U.S. economy, and improving economic data in the emerging markets, and these stock has been beaten up along with most financials during the past year. The current share price would be 3.00 a share if the company had not done a reverse split around a year ago.
To conclude, the market has moved up, and many traders and investors have missed some if not all of the move up. However, given that most macro data points in the U.S. and emerging markets remain weak, and pessimism remains high, its likely that the market could continue to move higher. With many popular technology and consumer staples already heavily invested in, I think it's worth looking at some of the more beat-up and under invested in sectors that could benefit significantly from an improving macroeconomic picture in the U.S. and abroad.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
