European Bond Auctions Perk Up World Markets

SUMMARY:
- European bond auctions perk up world markets, send commodities and stocks higher.
- SP500, NASDAQ move through the 127% extension.
- Import prices rise mostly on fuel costs.
- Fed Beige book again notes improvement, but it is the same old very slow improvement.
- Stocks continue the rally, moving higher into earnings . . . and the next resistance.

MARKET OVERVIEW

Worries about Europe and a technical resistance level hampered SP500 the past week, holding it in a lateral move. Wednesday the European worries were assuaged, at least for now, as Portugal and Germany held solid bond auctions that did not require yields as high as anticipated. With Europe out of the way and the early earnings coming in pleasing to investors, stocks were clear to take on the technical resistance, and SP500 along with NASDAQ took out the 127% Fibonacci extension on the open and held it nicely to the close. Indeed the indices fought off a mid-afternoon selling attempt and closed near session highs in a show of some pretty decent strength.

I said ‘for now’ with respect to the European issue because it keeps coming back with the tenacity and desirability of a mange-ridden stray. The debt issues are truly overwhelming on the continent. Portugal’s debt as a percent of GDP is something like 98.6%. Portugal must sell $20B in bonds this year to insure its liquidity. It’s market is puny, however, compared to Italy. Italy must raise 200B euro with bond sales to prop up its 1T euro bond market. Thus the ECB is adopting the US approach: buy bonds like crazy, and they are bringing in their own outside help with Japan and China promising to buy the ECB bond-aid, there is hope the PIIGS can ride through their issues and onto prosperity. . .

That was the mood Wednesday as world markets kicked the European debt can down the road and rallied across the board. Stocks, commodities, oil all rallied, apparently on the view Europe would come out just fine. Some good early US earnings reports bolstered the move as well. As noted, stocks gapped higher, rallied, and managed to hold the gains to close at or near session highs. All must be well in the world, right? After all the markets were up once again. Surely they are rallying on growth prospects versus, say, massive amounts of liquidity pumped into world economies by a couple of dozen central banks. Surely not. Bernanke himself says that the recovery is because of the liquidity pushing into financial markets, making people feel wealthier, and hopefully sparking an actual recovery. Kind of a ‘if you build it, they will come’ idea, though we are not sure there is any divine inspiration at work. More along the lines of a massive pucker by all of the world’s money men.

THURSDAY

Initial jobless claims, December PPI, and the trade balance. Oh yes, and more earnings. Just getting started, but the flood will start.

For now the early results are promising, enough so to help stocks break higher Wednesday, pushing the SP500 and NASDAQ through near resistance. The market certainly seems to have renewed momentum. Sectors that were under pressure are recovering, e.g. energy. Not all are going to recover; sectors in retail are questionable though some are still trying to rejoin the upside. Nonetheless, those recovering to join the fresher leaders are really providing the upside boost for stocks overall.

Earnings season often breaks into two parts. If it starts higher with investors psyched about the results, once the gist of the season is known and no newer and better earnings come along, then it runs out of gas and sells back. First part up, second part lower. If stocks run ahead of earnings that makes it all the more likely.

This one started higher and the initial response to the few results released is positive. The indices are already on a good run and after taking out the 127% extension they are right at the next price resistance. A bit more upside and they are dealing with that next level. Of course thus far they have shot them down one at a time, and if you were scared of heights you missed out on some great gains.

Now the indices are all the higher and still look as if they want to move even higher. Again, that will keep some out of the market. We have to say that we are not as excited about new positions at this level; the risk/reward is thinner, particularly as we don’t particularly like letting positions run through earnings. That puts a time constraint on positions. Of course stocks can continue to move right on through earnings, continuing runs. They can also, even with good results, turn on you, particularly if they have enjoyed strong gains ahead of results. You can play the range of possibilities using option spreads or buying puts to protect your upside positions. Or you can take partial gains on the way up as we have been doing and thus enter earnings season substantially lighter, having already banked a lot of the gain. Then if the results are good you benefit more. If they are not, the pain is much lower.

As a rule of thumb, if a stock has rallied well ahead of earnings, take part of the position off the table, at least half. After earnings and any gap, there are many ways to get back in. We love playing gaps after earnings, up or down. You can get a breakaway gap that will continue on. You can get a gap that moves to resistance or support and thus will likely try and fill; you can fade the fill and/or then play the move after the fill. Many ways to make money, great money, without the risk of riding through earnings. Yes we carry positions through earnings; it paid off in October handsomely. But we also are lighter by the time we get there.

For Thursday we continue looking for upside that is well-positioned to make us money. As you can imagine, those are getting a bit thinner and harder to find as the market advance continues. Many stocks are pretty extended, but then again, there are many just now joining the party, e.g. ISRG. Those previously ignored stocks often get a chunk of the new money moving to other sectors of the market.

There is also the downside that we have started putting on the report. With the indices moving up toward resistance, you want to be ready ahead of time versus scrambling once the selling is already underway. Thus our downside plays, and as the market moves higher and they follow, we adjust their buy points. As long as they remain in bearish patterns, we adjust the buy points each session. That way we are ready if the sellers attack the market.

You may wonder why we are letting some positions just run without taking any gain. Well, we have already taken a lot on many positions and are, as indicated above, heading into earnings season with smaller positions. Once we take gain a couple of times (e.g. a third the first time, a third the second), we let the rest of the position run until the market or individual stock turns on us and breaks the trend. That is called letting the market take you out. We are still amazed at how that last part of our position will continue to run and run well beyond what we ever thought it would. Thus we have some old positions on AAPL, PCLN and others that just keep on running so we let them keep on running.

Jon Johnson
InvestmentHouse.com
Stock Splits & IH Alerts, Editor