HOTS Weekly Options Commentary
Peter Stolcers
This has been a bloody week and I suspected that we were in trouble Monday when the market completely discounted the 10% drop in the Shanghai Index. After the muted reaction to that decline, our market finished a little higher. It wasn't until Tuesday that the real fireworks started. Concerns over higher interest rates were fueled by Chairman Bernanke's comments and England's quarter point rate hike. England's increase was largely expected and it should not have caught anyone off guard. Some analysts blamed the sell off on the surprise rate increase by New Zealand. I find that rather amusing given their small GDP and high 8% rate. The true culprit was a lack of news and a round of profit taking after a recent run-up to an all-time high. It took the market seven years to get to this point and heavy resistance should be expected.
Interest rates might be creeping up, but they are still near the low end of the 50-year range. Rates are not increasing because of inflation; they are rising because of global economic expansion. A positively sloped yield curve is good for the market and this rise will correct the current inversion. Corporate earnings have seen double-digit growth for 14 consecutive quarters. As a result, their balance sheets are strong and they are using cash to buy back shares or acquire companies. Last quarter was considered to be weak and earnings rose a healthy 6%. As you can see in the chart, over the last year the market has established a pattern of sharp declines that follow relative highs. The corrections are very short and steep and the recoveries are brisk. I do not see any evidence that the macro environment is changing. I do feel that many analysts have had to raise their interest rate expectations. None are more significant than Pimco's Bill Gross. He has been leading the charge for lower rates and he manages the largest bond fund in the world. This adjustment process creates chaos. I believe the market will get accustom to the "tight light" bias and it will put the relatively low interest rate picture back into perspective. Employment is strong and wages are increasing due to a tight labor market. Companies are profitable and the P/E ratios are reasonable. Inflation is relatively contained. Given these factors I do not see a doomsday scenario unfolding. I do see a market that needs to work off some excess and this is not something to stand in front of.
Next week's big economic numbers are the PPI and CPI. If they continue to show contained inflation, the market will rally. On the earnings front the only stock worth mention is ADBE. Overseas trading and M&A will have a bearing on Monday's open. If the market can get off to a good start and the PPI comes in on target, we could build on Friday's bounce. Option expiration weeks have been bullish and if the market starts grinding higher, buy programs could "goose" it even higher. Conversely, if the market can't sustain a rally next week, there is a chance that the lower support level of SPY 146 will be tested. I expect that level to hold. As long as it does, I will have a "buy the dip" mentality. This is a time to look for stocks with support and to wait for the market to show us that the 'bid' is back.
