Saturday, July 7, 2007

HOTS Weekly Options Commentary

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Peter Stolcers

Last week the market did not take a holiday with the rest of the country. It started the week strong on the coat-tails of M&A activity and it closed higher on Monday. That theme was revisited Thursday when Blackstone announced a $26 billion takeover of Hilton Hotels. Takeovers are creating a feeding frenzy and at any moment a stock can jump 10% higher on speculation. It is almost impossible to short stocks in this market. The trend is so strong that “even the dogs are barking ". That's “the street’s” way of saying that the weak stocks are rising with the tide.

The table was set for a positive reaction to the Unemployment Report. As I mentioned last week, this report has generated a positive reaction each month this year. Initially, strong employment numbers pushed the 10-year bond yield over 5.2% and the market reacted negatively. Traders digested the news and quickly concluded that full employment might actually be good for the economy. The wage inflation component came in at .3%. That is a little hot, but it was within expectations. Next week, the economic calendar is fairly light.

Consumer credit, wholesale inventories, trade balances, retail sales and consumer sentiment are scheduled for release. Retail sales has the potential to impact the market. As a sector, retail same-store sales only increased 1.2% in the last week of June. Last Tuesday, we learned that the percentage of loans that were 30-days past due rose to their highest level since 2001. Delinquencies on home mortgages are rising due to adjustable-rate loans and May marked the 26th consecutive month where the personal savings rate was negative. (As a side note, I will ride this market higher, but the negative savings rate has me very concerned 3-5 years out. Aging baby-boomers must start saving for retirement and that noose will draw tighter with every passing year.) The retail sales number will give us some insight on the strength of the consumer. My suspicion is that the number will come in light and the blame will fall on higher gasoline prices and the weather. Ironically, gasoline prices have actually come down during the last few weeks. I believe that inflation, debt levels and higher interest rates are tapping the consumer out.

Next week, the new earnings season will begin with Alcoa on Monday. The big releases won't kick in for another week, however, there are a few interesting stocks this week (AA, PEP. INFY, DNA, FAST, TXI, YUM, CTAS, GE). Yum could set the tone for the restaurant group. I feel this strong stock may be faced will the same issues plaguing the retail sector. INFY will give us some insights on rising wage inflation in India. DNA could spark a lackluster biotech sector. GE is one of the largest stocks in the world and it recently had a three-year breakout. I expect solid earnings from the industrial divisions to more than offset weakness in other areas.
From a technical perspective, the SPY is within striking distance of the all-time high. Even the tech stocks are making a new multi-year high and the QQQQ has shown relative strength. I still struggle with this sector because I have not seen a corresponding rise in guidance. Certainly there are pockets of strength, but overall, the earnings have not been revised upwards. Consequently, I still like keeping my money in the heavy equipment stocks and the energy group. I expect companies with an international footprint to do well. I'm a bit more skeptical of companies that rely solely on domestic revenues.

The market has become much more volatile in the last month and I suspect a major move is looming. Earnings are likely to determine the direction. Last quarter, low ball estimates were handily exceeded. Now the expectations have been adjusted and with rising interest rates it will be more difficult to surprise “the street”. The bid to the market is very strong and I am expecting a choppy move higher from this point on. It will be important to buy dips and to take profits on any rally that loses its steam. That pattern will continue until the Fed raises rates. I'm not expecting that this year so I believe we will have a good run the rest of the year. Stock selection will be critical.

Sunday, July 1, 2007

HOTS Weekly Options Commentary

HOTS Weekly Options CommentarySocialTwist Tell-a-Friend
Peter Stolcers

Last week the market opened with a whimper. Monday morning prices followed through to Friday's decline. Throughout the day it touched the SPY 149 support level and it bounced. Tuesday the market added to the decline and it broke below that support level. Just when things looked like they might finally breakdown, a snap back rally on Wednesday saved the day. Prices started out unchanged and once the bears exhausted their selling, the bulls took charge and rallied the market throughout the day. By the close, the S&P 500 futures had posted a 20 point gain. Thursday, a weaker than expected GDP report included "hot" inflation data and the market somehow viewed that as positive. Before the Fed released its FOMC comments, the market was moving higher.

Their rhetoric changed slightly and a few new words were added. After the release the market gyrated back and forth while it tried to decode the secret message. Friday, the PCE index showed that prices increased .1%, last month leaving the one year rate at 1.9%. That is just under the Fed’s 2% target and the market liked the news. I'm amused at the inflationary analysis. These numbers exclude food and energy. This is analogous to my neighbor analyzing my putting, "… apart from speed and direction, it was a great putt.” Soon they will need to exclude additional items and the report could read like this, “… excluding food, gasoline, health insurance, college tuition, medicine and travel - inflation is contained.” Obviously, the Fed is still concerned about inflation even if it doesn't show up in the standard metrics. Consequently, I believe the best case scenario is that rates will remain unchanged the rest of the year. Foreign interest rates are on the rise and it's widely expected that China will be the next country to raise.

A few weeks ago I came to the conclusion that the market would fall into a choppy, sideways trading pattern. My analysis was based on two facts. Earnings had been released and interest rates will remain unchanged. Those are the two driving forces behind the market and they are both "knowns". The market is searching for something to sink its teeth into and in the end; all of the little knee-jerk reactions will be meaningless. I did not expect an increase in volatility. It seems that once an intraday direction has been established, the buyers or sellers (whichever the case may be) step aside.

In this week's chart you can see that the volatility has recently expanded. Prior to June, the market was trading in a nice tight pattern. Now, large intraday price swings are common. Wednesday really caught my attention. Tuesday the market had a large range and it opened near the high and closed near the low. Wednesday the exact opposite happened, however Wednesday's open was below Tuesday's close and by the end of the day Wednesdays close eclipsed Tuesday's open. This created a large green candlestick and this is known as an engulfing pattern. It is normally considered to be bullish. What makes this so unusual is that the engulfing pattern occurred a day after an extremely large range. Friday was another example of a reversal. After a higher open, prices weakened and the market sold off going into the close. The S&P 500 has a 20 point range. An increase in the daily range usually precedes a large move. If I had to assign probabilities I would give the market a two thirds chance of breaking out to the upside and a one third chance for a breakdown.

The macro conditions are still in place for the market to move higher. Earnings are solid, balance sheets are strong, employment is robust, valuations are in line, interest rates are relatively low and inflation is "in check". The bid to the market is very strong and the market will continue to adjust to the notion of higher interest rates.

Next week’s economic releases are highlighted by the Unemployment Report that comes out Friday. Over the past few months, the market has rallied after the number. "Full employment" and moderate wage increases are good for the economy. The unemployment estimates have been in line, diminishing the importance of the ADP employment index (Thursday release). The ISM manufacturing and services numbers are also unlikely to have a major market impact in a quiet holiday setting. On the earnings front, I don't see a single stock that would catch my attention.

Next week you can expect a quiet week of trading. I believe that the recent volatility will start to calm down.

Have a great holiday!

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