Stocks Sell but Again Come Back From the Lows

SUMMARY:
- Europe rears up, US spending trails off. Stocks sell but again come back from the lows.
- Portugal debt instruments not looking healthy, Greece-like debt restructuring attempt likely.
- US December spending data corroborates Friday GDP report
- Market taking a pause, sporting good intraday action, but no need to get in a hurry.

More backfilling looks solid for now.

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Things have been going our way, but the action on Monday looked like it might try to head the other way. News out of Europe was once again raising its head. The main story was the debt issues and problems with interest rates jacking up to the skies on countries that are not perceived as very good risks. Monday it was Portugal. Amazing things are going on in terms of the numbers. It is not a great thing to see, but it is like watching a car wreck; you cannot look away. The 10 year bonds hit 15.8% on the yield. That is twice what is considered “stable.” We have seen Greece at these levels, but it has backed off.

Then there are the credit default swaps, a form of insurance taken to insure default on other instruments. The numbers are approaching pre-Lehman levels. It takes 3.95M euro to insure 10M euro worth of 5 year Portuguese bonds. That is staggering. You have to put up 40% of the money to insure the amount you want to protect. It is getting to be loan shark time, and that is the problem. Things get out of hand, no one trusts anyone, and they require more and more money to lend or produce money and feel they can get a “safe” return.

Portugal’s debt-to-GDP ratio is 105%. That is much lower than what Greece had, but it will likely need a debt restructure similar to Greece. I say similar, but Greece has not yet agreed to its debt restructure. Looks like the bond holders will have to take a 75% hit according to the latest stories. It is an amazing scenario in Europe. The Germans say they need more austerity, more deficit consciousness. Of course you do. They are raising taxes and reducing salaries as part of their austerity programs. Now confidence is plummeted because people see their taxes going up and their salaries going down. They see inflation and the bonds yields going through the roof. It is easy to see why confidence is getting hammered. While austerity is necessary   it should have been implemented years ago to work   Europe has to grow to get out of its debt crisis.

The U.S. will also have to grow out of its debt crisis. You are smoking peyote if you think we can tax our way out of the system. There is not enough GDP in the U.S. to pay this mess off. It is foolish to think we can solve our problems by raising taxes on so-called millionaires and billionaires. It may make some of those running for election feel better   it may even get them elected. A lot of people who do not understand the numbers will think that is what we need to do. “The rich have the money, so we need to have them pay it off.” We could confiscate the entire gross profits of the SP500 for 10-15 years and not pay off our debt. That puts it in perspective. I know everyone may be tired of hearing this, but it is not really a revenue problem. We have just spent so much that we cannot make the enough revenue to solve our problems. Or should I say TAKE enough revenue to solve our problems. Apparently many in DC want to go that way on both sides of the aisle.

That had its effect on the premarket action. Stocks were trading lower ahead of the hope open. It did not help that the Personal Income and Spending for the U.S. consumer came out ahead of the open. Incomes were up at 0.5% versus the 0.4% expected and 0.1% in November. That was the highest level in 9 months, but spending was down. It was flat versus the 0.1% gain that was shown in November. Incomes were going up, and we need this. We have had incomes going down and no one has had any money. Nice to see the incomes rising, but people are saving their income because they have been so low. Indeed, the savings rate moved up to 4.0 in December versus 3.5 in November. We had some not-so-great U.S. data coupled with new worries out of Europe.

These were not just possible bad stories; Portugal is really in trouble. If you want to look for a silver lining, Portugal’s economy is not huge. The next in line is likely Italy, and Italy’s economy is big. It does “matter” with respect to the EU. Italy is showing problems as well. It has had its bond market spike higher in yield, although it came back down after the facilities were put in place a couple of months back. I am worried it may be turning back to less savory times, but the U.S. markets are holding well above the eurozone level in a nice, normal test on Monday. Moreover, the dollar LIBOR held the 0.55, the level it ticked down to last week. That is a positive as well. We still have positives. But when these impressive numbers are coming out of one of the eurozone countries, it is worrisome. The markets were rattled.

Stocks were trading lower early. They opened lower, sold off into the first half hour, and then managed to make a comeback. Once again we had the low-to-high action. Only the NASDAQ 100 made it back to positive, but it was a good recovery with the Dow coming back from over 120 points down to close down just under 7 points. A solid recovery as the buyers once again stepped in on the session lows and drove stocks back to the upside.

SP500, -0.25%; NASDAQ, -0.16%; Dow, -0.05%; SP600, -0.85%; SOX, -1.1%; NASDAQ 100, +0.14%

TUESDAY

Tuesday we have more economic data, setting up for the jobs report on Friday. It is important stuff. There is the Case/Shiller Home Index for 20 cities and 10 cities. It measures the pricing. You have the Chicago PMI for January, a very important number. It is expected to decrease just slightly. Consumer Confidence is expected to rise, following along the Michigan Sentiment number. Confidence seems to be up. People bought a lot of cars. We will see how long it can last. If you get a little more money in the bank, you are feeling confident as well. Personal incomes went up in December, so there is a bit of confidence out there. That is a good thing to see because we have not had much to be confident about over the past 4-5 years.

That said, there will be more earnings as well. We cannot get away from them, but we are getting past the earnings hump. We have the gist of it. Remember what always worries you when you have had a pretty good move into earnings. Then the market knows what is going to happen, and they get saturated with the data. They do not think there is much that can change the way the market is moving, and they run out of bids. We have run out of the bids over the past three days, but it has not rolled over. No one is dumping stocks; they are just not buying them right now. They are letting them come back.

That is typical of a market that is in a healthy uptrend. You have buys on volume, and then they fade back as the bids dry up. They just let stocks drift, but they do not drift far because no one wants to sell. If no one wants to sell, stocks will drift back on no buying. But then you have a stalemate. Then new money will get put to work and it will bounce stock prices back to the upside. That is the theory.

With the good price patterns we have seen, they are definitely out there. There are stocks under accumulation. Those patterns just do not show up at random; they show up when big funds are buying stocks. They do not do it all at once. It happens over time. Then once demand outstrips supply, you see those big breaks to the upside that send stocks catapulting out of the nice little bases. Then they pull back and consolidate. If the market remains healthy, if it still looks good down the road and investors want to price in more gains, they will buy them up again.

That brings us to the dilemma we have had for the last week or two. We have the indices bouncing back up and bumping at the post-bear market highs spanning February into July 2010. That leaves this market, given how it is just below those highs, in not the best risk/reward position. As I have said, there are plays out there that look more than good enough in themselves and could continue to rise. We have been looking for those that do not have any resistance overhead. They do not have to break any resistance in order to make us money. Those are the ones we really like to see because they give us the best returns without having to worry about bouncing back down off of resistance.

Some plays that may be down in the early or mid-December levels would have been good plays worth making the play because the risk/reward probabilities were good. But they may not be as good now. Maybe they have to break through a little resistance in order to make that next move. They might still do it. I am not saying they would not. But they will have to work a little bit to get through.

LIFE is a stock that I have been looking at. It posted up in early January and then gapped to the upside. It has come back to fill that gap, but it is also right in the teeth of a lateral range that, as with the indices, marks those old highs. In order to make a good gain, it has to get through some serious resistance that runs from 50-53. That is a tougher call. It is tight, and it is hard to do. You have to bank on it wanting to push into that resistance. If we really want to make nice money, we have to have it break out over those June peaks. It can do it. I am not saying it cannot, but I look at things from the standpoint of probabilities. Maybe if the market was back at those December or November levels it would be a better play because there is more risk/reward there. There is more push up to the market overall to carry it higher.

Let us say the stocks make the break to the upside and the market does too, but then it decides it is going to reverse. Or it will just not make the breakout right now but come back and test as it did back in the summer of 2010. It made that test before it made the next break. Then just as our play gets underway, it gets thrown back on us. My point is that, while we still see good plays that we can make money on to the upside that still have plenty of room to move without having to break any resistance, we may have to take a pass on those that have to break some resistance. As much as we like them and as much as they look like they could make money   indeed, patterns such as this have made us money on this move higher. But now we have this resistance, and I am not interested in having to take that risk to make the money (that you could potentially make on the move to the target).

COH is sitting on top of the highs. It broke through. That is a better position. At least it has no resistance to stop it. It can just continue to move higher. Even so we still have to be careful with any position we take. We are not really taking full positions. We take a partial position and see how it works. If the market turns out fine, there will be plenty more buys moving higher. If there is a breakout over the old highs, it will be tested and we will be able to make money off of that.

As I said over the weekend, do not get too invested right now. We have been taking gain off of the table on the way up and we have been picking up some shares, but we have not been buying full positions. Do not get too invested. Let the market make its moves. Let it go through whatever test it wants to make. Rarely to you get the breakthrough on the first try. You get that pullback around the October peak or maybe a bit lower near the June low. Then we get a move higher. That may take two or three weeks. Likely enough to scare people out a bit. If everyone is buying on the dips   it happens sometimes   it could keep going forever. But usually you get a pretty good shakeout that rattles some nerves and scares people into thinking “Here we go again, back down into this eurozone range.” Once they get out and the easy money is gone, then the market will move back up.

We do not assume it will not make a breakout, but we do not assume it will either. It is time for patience. We keep watching for entries. Good stocks in good positions that we can make money on without having to have a breakout. Then if the market does, then we just continue to ride them further. Watch for the good setups, the good names in positions that can make us money without having to make a breakout. Then if the market moves up, we will do well. If the market does not, we take what we can, get out of the way, and then see how far it tests. Even today we were taking a little off the table here and there. We may take some more off the table if the action like we saw today starts to diminish.

We got a good rebound today, so I thought we would leave these on. If the market continues higher, that is great. But if we get a pullback that does not rebound, we will have to button up more of this gain we have and just wait for the test. We may miss a break higher, but that does not mean we will miss the next one. There is always a next one that gives you a good setup.

Patience is good right now. Patience is not a bad commodity to have in your bag of trading along with some good positions. Keep your head about you. Know where we are with respect to market history, and figure your risk/reward and what you want to put out there versus the reward you can take home. It is not the same as it has been. Keep that in mind. It will get back to that, but we may need a little test first.

I will see you on Tuesday. Have a great evening!

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