Much like the prior week, equity markets the world over climbed a bit of a wall of worry in the hope that summits and troikas will solved Europe’s debt woes……The SPX closed the week at its highest level for that period and matched its highest close since Aug 3rd. The index is up a little more than 15% from the intra-day low made on Oct 4th, the day we narrowly avoided entering into bear territory. The Chart of the SPX below shows 2 very obvious channels since the start of the year, one that felt pretty good, the Jan 1 to late July period where the range was 1250 (flat on the year) to about 1350 (up about 8% on the year)…….I guess the debt ceiling debate in late July was really the straw that broke the “PIGS” back in a way, as many of the issues that were blamed for the volatility in late spring / early summer (Euro debt crisis and the “soft patch” of economic data we started seeing in the U.S.) has mostly been brushed off until things started to crescendo on the break below 1250.
The second and latest channel that was recently broken to the upside was the 1220ish sort of area to 1100…..now this was obviously a bit more of troubling pattern than that of the prior one….this one corresponded with readings in the VIX above 40 for most of the period and the news just appeared to be getting worse and worse……At this point, and barring any disastrous news out of Europe, Friday’s close, pretty squarely in my mind, places the likelihood of new lows this year as pretty slim. Last week was important in some ways because our economic data was less bad, and earnings have been coming in gnerally a bit better compared to the less than enthusiastic expectations…..
Back to the chart above…while Friday’s close was impressive, we did close in that little no mans land….DMZ, or whatever……but the point here is that the resulting direction from the next move above 1250 or below 1200 could signal the course of the market for the balance of the year…..
This week we have a few significant events that could help catalyze the move….As most of you are aware by now, the 1st Euro crisis summit of the week that concluded today yielded ZIP, and now all eyes are on the second on scheduled for Wednesday……if this summit proves to be as useless as today’s then look out below, 1150 here we come……..The Euro leaders and finance ministers know this and should be doing everything in their powers to put their best foot forward….the problem from what I am reading is that the problems they have to solve, really solve, not just sound bites, will take years to do and will not be able to be done adequately in with a false deadline hanging over their heads…..this will ultimately cause greater volatility in my mind in the months to come.
The other event is the bulk of S&P earnings this week, about 200 members of the index…..t0 date I think it is fair to say that results have been mixed but generally have leaned towards the positive side, the glass is clearly half full………But I think there were a few outliers last week, for instance extended tech names that have been relative strength leaders on the year like AAPL and IBM saw weakness after earnings while beaten up bank stocks like BAC, C , MS and GS all saw strength on what was generally mediocre results……This action told me that there is not exactly a clear theme and we could get back to a stock pickers market that yields lower levels of correlation.
As we get away from he results of the high-fliers and bottom-feeders and get a better sense for how the meat of the S&P 500 is doing, we should get some sort of directional bias going forward……
Last week’s close clearly indicated that market participants are more worried about a melt-up than a meltdown, when you consider that we closed on 2 month high as we headed into a weekend that in my mind offered the potential for a great deal of disappointment……Hedge funds appear to be short and mutual funds are getting ready to gun their longs into year end if they get the all clear from Europe….this could continue demonstrate the risk to remaining short the market….
As many of you know I like to lay out shorts when things get a bit extended, and that is what I am doing now….I had a good week last week doing this in names like IBM and AAPL, and while I didn’t nail the bank long trade I will use the recent strength to add to some smaller short positions in names like BAC, MS and GS…….But I guess one of the most important things we are trying to do here at RiskReversal.com is demonstrate alternative ways to expressing contrarian views, while always looking to define risk. If we manage risk in a disciplined manner and always risk what we are willing to lose and not put ourselves in the position to be naked short anything, we will come out ahead in a big way…..The volatility we are experiencing over the last few months will not be here to stay and in some ways we should look to embrace it until it is gone…because as a trader, I will miss it when the VIX is back at 16!