Investors and traders get paid to take risks. Sometimes we get paid very well. Other times it's a painful reminder that we're still human and the best laid plans of mice and men often go astray. Last week was painful for our portfolio. Several stocks gave up 12% but these were the same stocks that saw huge gains over the last few months. The S&P 500 index, with its recent high of 956 and last week's low of 903 corrected just over 5%. Is the rally over? I don't think so. The S&P 500 rallied about 40% off its March 2009 lows. A 5% correction is very minor in comparison.
The S&P 500 bounced from support near the psychological 900 level and technical support at its 200-dma. The bullish trend of higher lows is starting to slip but it's still in place. There are only seven trading days left for the second quarter and the first half of the year. The S&P 500 is still up 15.5% for the quarter and if mutual fund and hedge fund managers are as under invested as everyone thinks they are then we could see significant window dressing between now and July 1st. Managers live in fear of under performance relative to their peers and whether they want to buy stocks or not they could be forced to just to "keep up".
Daily Chart of the S&P 500 Index:
Monthly Chart of the S&P 500 Index:
The challenge that bullish investors could face this week is fear of the Fed. There is a two-day FOMC meeting that concludes on Wednesday, June 24th. No one expects the Federal Reserve to raise interest rates this week but analysts and economists are eager to hear the Fed's comments. The focus will be if the FOMC changes their accommodative stance toward keeping interest rates low for an "extended period". The worry is that if the FOMC raises rates too soon it could squash the economic rebound. Yet if they leave rates too low for too long it will exacerbate the storm of inflation on the distant horizon.
Fed Chairman Bernanke has his own problems. Aside from keeping his job, Mr. Bernanke wants to keep mortgage rates low to help fuel growth in the housing market so consumers can refinance their mortgages and buy up the current glut of housing inventory. Unfortunately for Mr. Bernanke mortgage rates are tied to bond yields and the yield on the 10-year bond continues to climb. Yields may be forced to keep climbing if foreign investors need to be tempted to buy the monsoon of U.S. debt currently flooding the market.
Desire for U.S. debt will be tested again this week with a record-breaking $104 billion in 2-year, 5-year and 7-year notes. This surpasses the recent record high of $101 billion sold in one week in May and again in April. The only good news here is that this week's auctions are the shorter-term treasuries. Everyone is aware that inflation will be a problem down the road so investors are more interested in short-term bonds than the longer 10 and 30-year bonds.
I realize that talking about bond auctions can put some of our readers to sleep but investors need to realize that U.S. bond auctions will continue to garner headlines until the economy recovers. If the bid-to-cover ratio ever falls too low for U.S. debt we could be in serious trouble. One factor in favor of the U.S. debt auctions is that investors don't have many alternatives. Unfortunately, this gold standard of quality is starting to tarnish as the dollar falls and the government pumps out more and more debt. For now the U.S. still has a AAA credit rating but global investors are skeptical.
Next week will be dominated by the FOMC meeting but investors will also be watching the latest economic data like consumer sentiment, another regional manufacturing survey, the existing home sales number, and the next GDP estimate. However, one thing that could potentially overshadow all of it is an earnings warning. The second quarter earnings season is about to begin in two weeks and this is normally the time that corporations issue any earnings warnings. If we suddenly see a burst of earnings warnings it could easily sour investor sentiment.
The challenge is trying to plan for an unexpected event like an earnings warning. More conservative traders may want to consider buying short-term puts on the S&P 500 or another major market index (maybe the Russell 2000) as a generic hedge for your portfolio. If you do choose this route I'd consider doing it before the FOMC announcement around 2:15 p.m. on Wednesday.
Personally I suspect that window dressing will rule the week. Investors have been waiting for a pull back in stocks for weeks. We finally got one. It wasn't very deep but that's to be expected with trillions of dollars in cash sitting on the sidelines looking for an entry point. Technicians have already started talking about the "golden cross" in the S&P 500. A golden cross is a bullish buy signal when the 50-dma rises up and crosses over the 200-dma. That should happen this week for the S&P 500. It's already happened for the NASDAQ composite and it's happening right now for the Russell 2000. I'm not suggesting investors make decisions on this one signal but it's another clue that conditions are improving.
Let me say thank you to the readers that have sent me your ideas on potential LEAP candidates. Keep them coming.
~ James Brown