HOTS Weekly Options Commentary

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Peter Stolcers

Last week, the market tried to recover from the 350+ point Dow Jones drop on Friday. That first round of earnings featured financial stocks and their big write-downs spooked the market. As I mentioned in last week's commentary, I felt that the market would stabilize this week once a broader mix of earnings were released.

Through the course of the week we caught a performance glimpse from many different groups and sectors. The news was good overall and the guidance was decent. If you strip financial stocks out of the earnings picture, corporations have posted a 3% growth rate. That is much better than the flat earnings growth rate has been projected. The market found its footing and about one third of the companies in the S&P 500 have reported.





Next week is the “grand daddy” of all news weeks. We have an FOMC meeting, the Unemployment Report, and the busiest week of earnings releases. I believe the Fed’s dramatic action during the last meeting will give them a "free pass" this time around. They have made it clear that they are carefully monitoring economic conditions and they will do what it takes to keep us from going into a recession. Many analysts are looking for a .25% rate cut. If they don't get it, I feel the market will be accepting if the news includes dovish rhetoric. The dust will settle for a few days and the market will wait for the Unemployment Report. If we do get a rate cut, we will be off to the races.

Last month's employment figures were much stronger than expected. With the exception of the August number, the market has been able to rally after every Unemployment Report this year. I believe the employment picture is sound and the market will rally after the number.

Microsoft has been a dormant stock for many years and on Friday it staged a major breakout. It is a mega cap stock and it could lead the sector higher if it wakes up. Tech has been relatively strong recently and the sector could lead the market higher if the earnings continue to beat. The QQQQ is still only half of its “tech bubble” peak. Financial stocks are weak and the market needs leadership from the tech sector if it is going to stage a sustained rally. In the chart you can see how well the QQQQ has performed. It is bumping up against the relative high and it is poised to breakout.

These are some of the earnings highlights for the week ahead: ASH, CAN, HUM, K, RSH, SCHN, ATHR, FTI, OSG, SOHU, UHS, VTRX, AMED, AVP, BJS, CRDN, CL, ENR, CMC, FPL, RAIL, GT, HLT, MGM, ODP, PG, TEVA, TRW, X, UA, BWLD, CMG, DWA, FIC, GPRO, IVGN, LNET, MCK, RTI, PCU, WBSN, CCJ, CRS, GRMN, KFT, COL, SPW, RIG, WY, ANDE, ABX, XRAY, FMC, MTW, PHRM, TK, AGU, AZN, BDX, CAM, CVS, DNR, XOM, GTI, IGT, MRO, PCS, OSK, ROK, TBL, UTHR, WMB, CLF, CROX, CYTC, ERTS, GES, OII, WLT, WDC, CVX, EDS, IP, OMG, TLM. I see more good than bad in this list and the numbers should have a positive influence on the market.

We are headed into one of the most bullish periods of the year and I expect a year-end rally. Given all of the news next week, the market will find a catalyst to push it to new highs. End of month buying will also help to support prices.

HOTS Weekly Options Commentary

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Peter Stolcers

With the exception of financial stocks, most sectors have been beating expectations. Financials are not some small little part of the overall market; they comprise 20% of the S&P 500. Last week was laden with earnings releases from national/regional banks, mortgage lenders and brokerage firms. This week, we will see a much greater mix of earnings.

SLB posted nice earnings and it was down by more than $12. In fact, all of the oil stocks were hit hard Friday. Oil is near $90 and that might become an issue for the market. I still believe that energy is one of the best investments and once this pullback stabilizes it will present a great buying opportunity.

CAT posted a 21% increase in earnings; however, they lowered guidance for the next quarter. They painted a very weak picture for domestic construction. Last week housing starts fell to a new 14-year low and the Beige Book indicated weaker economic conditions across the nation.

The dollar continues to drift lower and it is making new 30-year lows against most major currencies. This will eventually translate into inflation and that will put upward pressure on interest rates.

After a day like Friday, it is easy to focus on the negative issues. I believe we could see continued weakness for the next week or two that tests some of the major support levels. The last few days of October mark the beginning of the strongest bullish seasonal pattern of the year. I believe we will work off the worries and rally into year-end.

The economic numbers are very light this week. Durable goods orders, new home sales and Michigan sentiment are the only scheduled releases. Obviously, durable goods orders are the most significant release since they reveal our appetite for big-ticket items.

This is a list of some of the upcoming releases: ECL, ZBRA, NFLX, TXN, AKS, AXE, ARW, COH, CBE, JCI, LMT, PCAR, PCP, POOL, SHW, SII, AMTD, UPS, WHR, AMZN, BRCM, HOKU, JNPR, NVLS, PNRA, TRMD, STM, XL, ATI, BA, CME, GLW, FCX, LM, MER, NOV, NSC, NOC, PFCB, R, SLAB, TASR, WLP, AKAM, ACL, CLB, FFIV, MNST, STR, SYMNC, TEX, TSCO, ZMH, AET, BDK, CELG, CMI, GO, DOW, HET, MOT, PENN, POT, ROK, SO, SU, AMGN, AVID, BIDU, CENX, CLF, CYTC, KLAC, MSFT, WFR, SWIR, ABFS, CFC, CVH, FO, IR, ITT, LZ, TDW, WMI

They are in chronological order so that you can follow along as the week progresses. The current estimates are for flat earnings growth. I believe that will be an easy hurdle to clear. Corporate guidance is the key as traders look to the future. By the end of next week we will have a much clearer picture.

Corporate earnings have been strong, the unemployment rate is low, interest rates are low, tax rates are low, inflation is in check and global expansion is helping us through this rough patch. All of these conditions might be on the brink of changing; however, I don't believe that they will deteriorate before year-end.

I am patiently going to wait for support to be established and then I will buy this dip. I do not want to try and short this market for fear that I will get caught in a whipsaw. I got caught short last March and I learned from my mistake. In August, I bought into the weakness and took profits during the snap back rally.

During the last 3 quarters, the first week of earnings season has started off poorly. I expect a better week ahead.

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HOTS Weekly Options Commentary

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Peter Stolcers

Last week a stable Employment Report was released and the market surged higher. Despite mixed earnings announcements and soft economic releases, the market was able to add to those gains throughout the week until Thursday afternoon. "Hawkish comments" from one of the Fed Officials spooked the market, creating an intraday reversal. Chinese stocks were hit hard along with other stocks that have recently posted big gains.

Friday morning, the “all clear” sign was given. Chinese stocks held firm overnight and the PPI and retail sales numbers came in better than expected. The market was able to bounce and it closed above the highs made a week ago.

The economic releases this week are: industrial production, CPI, housing starts, LEI and Philly Fed.

I believe the earnings guidance, not the economic news will drive prices during the next few weeks. They are forward looking as opposed to the hindsight provided by economic releases. If GE and MCD are any indication, the earnings should come in at or above expectations. Both posted solid results.

Next week we will get an onslaught of earnings releases. I expect most companies to meet estimates and the current projected growth rate year-over-year is flat (0%). I believe that threshold will be cleared easily. The wild card is the earnings guidance that corporations will provide. If future weakness becomes a theme, the market will decline. If the earnings and guidance are consistent with the market's expectations, the market will continue to push higher.
These are some of the companies that are announcing this week: C, ETN, DNA, JBHT, JNJ, USB, WFC, INTC, STX, YHOO, ABT, MO, CIT, KO, ITW, JPM, UTX, ALL, EBAY, ILMN, ME, SYK, BAC, BGG, NUE, PH, PFE, RS, STJ, UNH, AMD, CREE, GILD, GOOG, IBM, ISRG, SNDK, TPX, VFC, MMM, CAT, HOG, HON, SLB.




We are only two weeks away from a seasonally bullish period. The earnings releases have been decent, we have not had many earnings warnings and the economic releases have been positive. As long as Americans have jobs, they will continue to spend and pay their debts. Add the Fed's half point interest rate cut to that equation and you can see why I am bullish. As long as the SPY is above 150, we will trade from the long side.

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HOTS Weekly Options Commentary

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Peter Stolcers

This week the market fell into a very tight 30 point trading range on the S&P 500. In the absence of news, light directionless trading set in. The economic releases came in slightly better than expected, but everyone knows they are hindsight. It is the future the Fed is concerned about.

This same scenario will unfold next week during the first four days. The economic releases are very light and they include the ISM numbers, building permits and auto sales. PEP, WAG and RIMM are the only earnings worth mention.





The fireworks will let loose on Friday with the release of the Unemployment Report. The weak number last month paved the way for the Fed to lower interest rates. If there is an increase in unemployment, the market will have a negative reaction. On the other hand, solid employment could prove that last month’s decline was an aberration. If this unfolds, the market will make a run at the all-time high.

I still suspect that the market is headed higher. Global growth is fueling our economy and housing only makes up 5% of our GDP. Earnings are right around the corner and we have not had an earnings warning outside of the home building sector. BSC and LEH were supposedly “exposed” to sub prime and both posted decent results. As companies release earnings, their guidance for next quarter will have a tremendous influence on the market.

This market can swing either way. While we wait, we will stay balanced.

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Peter Stolcers

Last week, the Fed pulled a surprise move when it lowered interest rates and the discount window rate by .5%. The S&P 500 futures rallied 25 points instantly. It was able to add to those gains on Wednesday and prices are holding firm.

I have been opposed to the Fed lowering interest rates because all of the economic data suggest "full employment" and moderate growth. The exception to this is housing, which only accounts for 5% of our GDP. If the economy continues on a moderate growth path, this ease will translate into a new record high for the market.

Don’t be fooled, on a relative basis the market is not near an all-time high. Once the Fed’s actions were revealed, the dollar got hammered. The market is dollar denominated and a foreign investor buying the SPY would pay much less for those shares now than they did at the prior high two months ago. For anyone who has recently traveled abroad, the decrease in our purchasing power is blatantly obvious. A weak dollar is an inflationary event and it is one reason why dollar denominated commodities like oil and gold are increasing in price. For the first time in 31 years, the US and Canadian dollars are trading at parity.





Enough about the dollar, I’m concerned that the Fed sees the big picture and that economic weakness lies ahead. They have been interviewing top CEOs and gathering unique data to gauge what lies ahead. Chairman Bernanke has been a steadfast inflation fighter and he had to be concerned to take such dramatic action. The market would have been satisfied with a .25% ease combined with help at the discount window. He had the option to wait for further evidence that the economy was slowing, but he didn't.

There aren't any earnings announcements worth mention next week so the market will look to the economic releases for direction. Consumer confidence, durable goods, GDP, personal income, core PCE inflation and Chicago PMI are on deck. Those numbers are like looking in the rear view mirror and they may give the appearance that all is well. Consequently, the market is likely to rally and test of the all-time highs this week.

The only way to trade this market is to stay long commodity stocks and equipment manufacturers that generate more than half of their revenues overseas. There are also select technology stocks that I like. I fear that the market could hit another "air pocket" once the first weak economic number hits.

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Peter Stolcers

Let me start by welcoming many new subscribers this week. I live for set-ups like the week ahead and the opportunities are lining up. I’m glad to have you onboard!

This is the calm before the storm. Last week the market rallied on expectations that the Fed will lower rates. The debt market has priced in a 70% probability of a .25% rate cut and the 30% probability of a .50% rate cut. The dismal Unemployment Report dramatically increased rate cut forecasts.

The U.S. dollar hit new 30-year lows against the Canadian dollar and against the Euro this week. We have a huge trade imbalance and a weak dollar forces us to pay more for the goods we import. Translation: a weak dollar is inflationary. Oil has just hit an all-time high. Last week, TSN said that profit margins are being hurt by higher food costs. I've even heard that Italians are boycotting pasta because wheat prices have forced it up 25%. There are countless examples of inflation (tuition, health care, local taxes) that don’t show up in the Fed’s numbers. Tuesday, a “hot” PPI number could add to the excitement.

I believe the Fed will reluctantly lower interest rates by .25% next week. They will lace their rhetoric with inflationary comments to curb future rate cut expectations. The market will have an initial negative reaction.





The earnings releases by LEH, GS and BSC will be much more important. To a degree, the Fed’s actions are priced in. However, no one really knows the earnings impact from the sub-prime/credit crunch debacle. Historically, LEH has made a 2% move after releasing its earnings. The option implied volatilities are pricing in an 8% move in either direction. Lehman releases before the open Tuesday while Goldman Sachs and Bear Stearns will be releasing earnings Thursday, after the Fed's decision. FDX also announces this week and transportation activity measures economic strength. GIS and CAG will shed light on food costs.

Earnings and the Fed’s actions/statements will determine the market's direction for the next month. Quadruple witching will throw gasoline on the fire, accelerating the move. All you can do in these situations is to have your stocks lined up. We will trade relative strength and weakness in a balanced manner.

HOTS Weekly Options Commentary

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Peter Stolcers

I have been bullish on the economy and Friday's unemployment number tainted my bias. I did not expect the dramatic decline this month and I certainly didn’t expect the huge revisions for June and July. For the month of August, analysts were expecting 115,000 new jobs. The actual number showed a decrease of 4000 jobs. That is a whopping 119,000 miss. June and July numbers were reduced by about 81,000 in total.

High consumer debt levels (and I'm not just talking subprime mortgages) will threaten the strength of this economy if workers get laid off.

Last week, the Fed invited major homebuilders to share their perspective on the economy and I’m sure Chairman Bernanke got an earful. A rate cut is almost certain after this dismal employment report. Inflation is in check and now the Fed can ease rates without the appearance of a subprime bail out.

Next week the economic calendar is light with consumer credit, retail sales, industrial production and consumer sentiment on deck. These releases don't pack the same punch and I believe Friday’s Unemployment Report will induce selling pressure until the FOMC. Traders are scrambling to determine if the Fed will cut rates by a ¼ or a ½ point.

If the Fed reacts quickly and lowers the rate by a ¼ point before the FOMC, it might be viewed as a progressive move and that might be enough to satisfy the market. On the other hand, a ¼ point cut during the FOMC will not carry the same urgency. The market could view that as stingy, feeling that the data justifies a ½ point rate cut.




In this week’s chart you can see the long-term uptrend is still intact and the breakout from April has also held. If the SPY 145 level is violated my bias will turn bearish.

We have bullish positions and this week’s trade will hedge some of our risk.

HOTS Weekly Options Commentary

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Peter Stolcers

When John Vogel, the founder of Vanguard Funds, says that in his 50 years of investment experience he can't recall this type of volatility, it means something. He is one of the industry’s innovators and you would think that he has seen it all. Huge day-to-day reversals have become the norm. From a trader's perspective it means one thing – uncertainty.

The bulls are very strong in their conviction and they believe that the current decline represents a fantastic buying opportunity. They point to the low unemployment rate, solid earnings growth, global expansion, and relatively low interest rates as signs of strength. Most quantitative models show that stocks are an attractive value.

The bears also have a long list of items to substantiate their bias. They point to increasing debt levels across the board (federal, state, municipal, personal) and they believe the credit squeeze is just beginning. From 2000 – 2005, almost 50% of the employment growth came from the housing sector. This number includes lenders, realtors, construction workers... everyone. They believe that the sub prime woes will continue to spread into other areas and the unemployment rate will rise. They also believe that hedge funds are highly leveraged and that the current credit crisis could force another round of liquidations. In a worst case scenario, they believe that some of the “fluff” will be taken out of the emerging market run up. Once profit taking sets in, that could have a cascading affect as investors run for cover.

Personally, I'm going to stay out of this fight. When a winner emerges I will know who to back. In the meantime, the implied volatilities are very high and option selling strategies make sense. This is a time to rely on stocks with relative strength/weakness and to keep your distance from the action.

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Peter Stolcers

Thursday's price action was very telling. The market had posted five consecutive late day rallies and it received a dose of great news after Wednesday's close. Bank of America was making a large investment in Countrywide Financial. In after-hours trading, the S&P 500 futures gapped 10 points higher on the notion that mortgage lenders present investment opportunities.

As the market prepared to open Thursday morning, those gains started to deteriorate. Soon after the normal trading hours started, the futures fell back to unchanged. At that juncture it was difficult to determine if the market had reached a resistance level, or if traders simply felt that the news did not justify the reaction. The momentum from the early reversal paved the way for bears to maintain selling pressure and they were able to push prices lower. By late afternoon, the market was able to stage another rally and finish unchanged for the day. The SPY 146 level was preserved.

This price action shows that buyers are willing to step up and buy stocks. It also demonstrates that we are not going to have a melt up rally. A great deal of nervousness still exists and any rally will be hard-fought.





Friday, strong durable goods orders created a bid to the market. That positive economic news was complimented by new home sales that came in better than expected.

The market avoided a sell off Thursday and it mounted a constructive grind higher on Friday. This week there are many economic numbers that will be released. Barring any new sub-prime defaults, I believe the economic numbers will show stability and they will pave the way for a continued rally. As we move above SPY 146, greater pressure will be placed on the shorts to cover. Next week, the market should also gain strength from end-of-month buying.

Here are some of the stocks that will announce earnings: SNDA, BGP, SAFM, BIG, BWS, JOYG, WSM, PSS, COST, CIEN, HRB, SHLD, TIF, DELL, FRO. As we saw this week, most of the bad news has been factored into the retailers. HPQ announced last week and I don't feel DELL’s numbers will pack any punch. Earnings will not have much of a market impact this week.

The shorts are no longer able to sell into every financial stock rally. There is a bid in those stocks and stability there will fuel the market since they comprise 20% of the S&P 500. It's still too early to give the all clear signal. This sell off was different from the one we had in February. Back then, there were phantom lending issues. This time around, the market had a more severe reaction as it counted the casualties.

As a side note, I feel the Fed has handled this crisis masterfully. They provided assistance when needed without compromising their stance or bailing out corporations that made poor lending decisions.

HOTS Weekly Options Commentary

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Peter Stolcers

Here are the nuts and bolts from this week's action. The sell off was caused by loose credit and poor lending decisions. Defaults had a cascading affect and they started a run on short-term debt instruments. That liquidity crunch culminated when T-bill rates dropped 1% this week. That type of move is almost unprecedented.

The squeeze spilled over to brokerage firms and they raised margin requirements to control risk. Instantly, hedge funds that utilize quantitative analysis were forced to liquidate their holdings. They employ a long/short portfolio strategy where they buy value and sell "fluff". Theoretically, they are market neutral. Many financial institutions view this as a conservative strategy and they allow these hedge funds to leverage up to an 8:1 ratio. When brokerage firms change the rules, the hedge funds have to pare their holdings. That is why we saw so many quality stocks get trashed this week. Companies that just announced earnings and raised guidance were pummeled even though they trade at low P/E's.

The sell off Thursday was exacerbated by option expiration sell programs. Regardless, the market staged an impressive intra day reversal without the help of the Fed. Friday morning before the open, the market was down 25 S&P 500 points in response to overseas declines. As the opening approached, the futures were only down 8 points. Clearly, we were near a short-term low. At 7:15 a.m. CST, the Fed lowered the window discount rate to avert a liquidity crunch and the rally was on.

The Fed’s action allowed financial institutions to pledge securities and borrow cash. This allows companies to meet their short-term obligations without having to dump their holdings at artificially depressed prices. The Fed has not had to use this tool for many years.

There are many other leveraged “conservative” strategies like this and when liquidation is forced, the market is thrown out of whack. The yen-carry trade is a widely-cited example. The most important thing to remember is that the macro business conditions remain intact. The adjustment process needs to run its course before everything can return to normal.




The Fed has conveyed that they are aware of current market forces and they are on alert. Next week the economic releases are very light. Retailers make up the majority of earnings announcements and dismal results are priced in. The market has staged back-to-back late day rallies and I believe it will follow through next week. If it can get above SPY 146, that would be a short-term bullish sign.


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Peter Stolcers

Two weeks ago I was talking about how the market might stage and expiration related rally that would fuel it to new all-time highs. The basis for that prediction was strong earnings and a large open interest of in the money calls. When that rally failed to materialize, a warning shot was fired.

A warning shot was also fired last February when the S&P 500 dropped 50 points in one day. Liquidity and credit risk were perceived problems and traders headed for the exits at the first sign of trouble. The difference between then and now is reality. This week hard numbers were attached to the losses stemming from loose lending practices. Technically, this decline has caused serious damage. The SPY penetrated the 146 support level. That represents the breakout from last April and it also represents the 200-day moving average. This juncture is a pivot point. If the market continues to trade below this level, lower prices lie ahead. If the market can recover and rally above this level a bounce and recovery could materialize.

There is new information that needs to be digested by the market and that process will take a couple of months. In the meantime, there will be bullish and bearish opportunities. It will be critical to find relative strength and weakness within the market.
I still believe that a year-end rally is in the cards. The earnings growth rate is in the high single digits at this stage of the earnings season. That is considerably ahead of expectations. Interest rates have declined and that is also bullish for the market. Oil prices backed off from their highs when forecasters lowered their expectations for hurricane season. Foreign markets are holding up relatively well and global expansion should carry us through this soft patch.
Next week the economic releases are very light and I don't feel they will drive the market. These are some of next week’s earnings announcements: NILE,HET, DRQ, TXU, TYC, ATW, CSCO, FLR, MDR, WYNN, AUY, AGU, BIG, FWLT, FLS, GES, LVS, CRM, ZUMZ, GME, SHLD, BRCD, DELL, FMD, ANN

I am expecting another volatile week. As the market tries to determine its next direction, it makes sense to lay low. Many traders are taking time off and thin trading is adding to the intraday volatility. I will follow their lead and I will be taking the week off as well. I will not be producing a new report next week, but I will update the current positions.
I’ll be clearing my head and preparing for the opportunities that lie ahead the rest of the year. If you decided to trade next week, keep your size small, stay balanced and take advantage of the high implied volatilities by selling out of the money credit spreads.

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Peter Stolcers

Last week I did not like the way things were shaping up. I expected to see continued strength from cyclical stocks as they posted good earnings and I expected to see strength in the financials once they demonstrated their lack of exposure to tightening credit markets. I believed those two events were going to rally the market to new all-time highs during option expiration week. The negative reaction from both groups told me that the market was in trouble. When I looked ahead at this week’s economic numbers I did not feel that there were any that might influence the market. In hindsight, that was fairly accurate. Housing numbers were the fly in the ointment. The market has become numb to the bad news from the sector and it had braced itself for more of the same.

The shock came when CFC, considered to be one of the sharpest lenders, hosted its earnings conference call. They described how loan defaults are spreading to other areas and the market panicked. CFC has been proactive in managing their risk and the market was shocked. As the week unfolded, the selling pressure increased. Once the market gained selling momentum the buyers pulled their bids. After a few air pockets, the bottom fell out Thursday. At its worst level, the market was down 50 S&P 500 points. It had small afternoon rally and that pared some of the losses. On Friday the market looked like it might fight off a number of attempts to push it lower. The bears got their wish in the last 30 minutes and once again, the bids disappeared going into the weekend. The drop felt like there were no buyers, as opposed to too many sellers. I won’t discount the move since it easily made its way down to a major support level at SPY 146. I did not expect that.

The magnitude of the decline this week was bigger than what we saw in February. In fact, this was the worst 5-day period since the year 2000. The market has new information that it needs to digest and it’s likely that this round of selling will take more than a few weeks to work off. The market will bounce and test support levels during the next two months before it settles down. Increased volatility will remain through September. Any attempt at a year-end rally will have to include the financials and tech.

Next week’s economic releases will include personal income, the PCE price index, Chicago PMI, consumer confidence, ISM and the Unemployment Report. The unemployment report is the most important release and it has been bullish for the market every month this year. A 4.5% unemployment rate and hourly earnings that are outpacing inflation are positive for the economy. I believe this report and end of month buying will support the market and rally stocks from an oversold condition. I’m not looking for the market to resume the rally; I just feel it will repair some of the damage.

These companies are slated to release earnings this week: APC, GEHL, HUM, MTW, MNST, RSH, VZ, TSN, VMC, AVP, BWLD, CAM, RIO, XRAY, MRO, MET, NVT, VLO, ANDE, CBI, CI, ERTS, GRMN, PH, SOHU, SBUX, TWC, TRW, ATK, AMT, RATE, CKP, EK, JSDA, RDC, WLT, PG, TM, WY.





If the SPY closes below 146, my bias will switch from bullish to a neutral. Earnings have been decent and interest rates are coming down. I feel U.S. stock valuations are reasonable and as a nation, we have full employment. These are all positives for the market.

That said, I do have some concerns. When money is loose, people get sloppy. That’s true for home buyers, bankers, builders, asset managers… Tightening credit markets remove inefficiency. American consumers are tapped out. We are entering our 27th consecutive month of a negative personal savings rate. This can’t go on much longer. Global equity risk exposure is also a real danger. No one really knows the magnitude of the yen carry trade. We can only hope that traders and brokerage firms reacted to the warning shot that was fired last February. As credit tightens, brokerage firms raise their margin requirements. If hedge funds have to reduce their holdings, that selling could spillover into our market. I also suspect that many emerging market equities are overvalued.

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Peter Stolcers

Two weeks ago the market staged a convincing rally to new all-time highs. The buying continued right in the close Friday and it looked like the table was set for an awesome option expiration week. Throughout the course of this last week the market had some large intraday swings but it was unable to add to the breakout. Going into the week I expected solid earnings from financial stocks to spark that sector and fuel the market.

Merrill Lynch and State Street Bank both posted big numbers that handily beat expectations. To my surprise, both stocks sold off even though their exposure to subprime lending is limited. Clearly, higher interest rates are the larger concern. They have the potential to impact consumer spending, corporate financing, and private equity deals. Without the help of the financial sector, a sustained rally is unlikely. These stocks comprise 20% of the S&P 500. Tuesday, Bear Stearns dropped the second shoe on subprime lending woes when it announced its hedge funds in that area were going belly up. The magnitude of this problem has yet to be identified. In the second day of his testimony before Congress, the Fed Chairman said that subprime lending issues will get worse before they get better. Years ago, home buyers opted for 3-year and 5-year ARMS and those adjustable rate mortgages are just starting to kick in. As long as the unemployment level stays below 5%, I believe homeowners will be able to adjust their spending patterns and avoid catastrophe.

In the chart you can see the QQQQ/SPY overlay. Tech stocks have been strong relative to the SPY. They broke out and they have continued to make advances while the SPY has stalled. Tech stocks are still 50% below their peak from 2000 and they have lagged the rest of the market. I have not bought in to the recent tech rally because guidance has not been raised. Only 13 stocks account for the recent NASDAQ 100 rally and the move lacks depth. Last week, two tech leaders (Intel and Google) failed to meet expectations. Cyclical stocks were even more disappointing. They released solid earnings and in many cases beat expectations, yet the stocks sold off after the news. Friday, Caterpillar announced earnings and missed expectations. This overall price action tells me that stocks in general are “fully priced”. Unless we get an extraordinary round of earnings next week, I fear that the market might be putting in a temporary top.





I don’t believe that the economic numbers next week will drive prices. On deck we have new home sales, durable goods, GDP and consumer sentiment. Interest rates will stay put for the rest of the year and that places greater importance on earnings.

I can’t possibly name all the companies that are announcing this week, but here is a list of some that I’m interested in: ACI, ALTR, AXP, CNI, RE, HAL, LNCR, MRK, NFLX, TXN, STLD, AKS, AMZN, T, BTU, BP, BNI, CDWC, DD, LLY, ENR, LM, LMT, NOC, PCAR, PNRA, PEP, PCP, SII, UPS, VRTX, AKAM, AAPL, CL, DADE, FFIV, FMC, FCX, GD, OSG, SLAB, TSCO, ZBRA, ZMH, WLP, MMM, AET, AMGN, BZH, BWA, BDK, BG, CLF, CRS, F, KLAC, NTGR, ODP, POT, SI, SPAR, DOW, WEN, WDC, BHI, CVX, IR, LZ, SEPR.

As I look at the list, I can’t visualize where the strength is going to come from. Energy, mining and heavy equipment are all priced for performance. The tech stocks on the list have performed well and they are trading at lofty P/E ratios. The chemical stocks have the potential to outperform and they are just showing signs of strength. Unfortunately, they won’t be able to carry the market. I’m expecting a choppy week of earnings and the market will do well just to hold its current level. If it falters and it falls below SPY150, it could retest the relative lows we made in June. I would be suspicious of any rally that does not include financials stocks.

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Peter Stolcers

Monday, the market tried to resume the prior week’s holiday rally. It struggled to add to the gains and by Tuesday morning and it looked like the market had added a third lower high to the technical pattern. If you had connected the tops from each rally you would have seen a downward sloping resistance line. Sears and Home Depot provided a dismal glimpse of retail sales and Moody’s announced that they were about to downgrade sub-prime lenders. Tuesday morning’s decline was exacerbated by a prepared speech that was delivered by the Fed Chairman. By late afternoon, the market was in one of its typical “no-bid” slides. The S&P 500 closed 20 points lower. After sleeping on it, traders realized that the Moody’s news was already “baked in” and that Ben Bernanke did not shed any new light during his speech. Wednesday, the market started off on a nervous note and it rallied strong right into the close. Thursday, the market jumped higher after retail sales beat dismal expectations. Legitimate buying and short covering fueled the market to its largest one day gain in years. Friday, GE posted better-than-expected earnings and the market was able to make new all-time highs.

As I’ve been saying, no matter how ugly this market looks, it has the potential to annihilate short sellers at a moment’s notice. In this week’s chart you can see the strong trend and the temporary consolidation phase we went through the last two months. The big picture looks as bullish as ever. The trend lines are in place and there are multiple breakouts to suggest a continued move. If you simply viewed a daily chart, the market looked like it was ready to rollover. Over the last few weeks I have also pointed out that the volatility has increased. That is normally a precursor to a big breakout. That’s exactly what we got this week and I believe we will see continued strength next week.







From an economic standpoint there are a few big releases (PPI, Capacity Utilization, CPI, Housing Starts, LEI, Philly Fed.), but all eyes will be on the inflation numbers. The Government’s definition of inflation is different from mine. I feel that prices are moving higher in many areas (healthcare, college tuition, gasoline, travel), but those increases are not reflected in their calculations. As long as the market feels that inflation is contained, that’s all that really matters. The market has actually been able to rally off of the last couple of PPI and CPI numbers. I expect the same this week. In fact, I believe that all of the economic releases during the next two weeks will take a back seat to earnings. Earnings and interest rates drive the market and right now interest rates don’t look like they’re going anywhere.

Next week we will get a huge round of earnings releases. Here are some of the stocks that are on deck: ETN, GWW, REDF, AMD, FCX, MER, MOT, NFLX, PCAR, INTC, JNJ, MAN, WFC, YHOO, ABT, JPM, PJC, AOS, UTX, MO, EBAY, PFE, TER, TEX, ALL, JNPR, ME, DHR, HOG, HSY, HON, POOL, RS, TXT, VFC, BAC, BAX, CY, GOOG, IGT, ISRG, MSFT, NUE, BRCM, COF, SNDK, STX, SYK, BIDU, CAT, C, SLB. There are some great plays and some traps that lie ahead.

Strangely, the market is taking comfort in higher oil prices believing that it confirms robust global expansion. Liquidity is creating a supply/demand imbalance in equities. Flush with cash, corporations and private equity firms are aggressively buying shares and they are taking the shares out of circulation. Meanwhile, new funds continue to flow into the market. The macro conditions are in place for a continued rally and as good as things might seem in the U.S., we are the weakest link internationally.

I believe the market rally is legitimate and that earnings and option expiration will overpower any potential weakness in the economic releases. The market has rallied to a point where option related buy programs will be prevalent next week.

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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.

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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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Peter Stolcers

I’ll start by saying that I am bullish over the next six-month period. Earnings are strong, valuations are in-line, interest rates are relatively low, employment is high, inflation is in check and global economic growth is robust. On a short-term basis I'm starting to see some warning signs. The market has run up and we have not seen a decent correction in a very long time.

In the chart you will notice a few developments. The volatility has increased greatly and it is depicted by the long red-bodied candlesticks. Two recent events tell me that the resistance level at the all-time high is growing. The first event happened two weeks ago when we had the gap down after the all-time high was established. That was followed by a very bearish down day. After the market had one of its typical snap back rallies, it was not able to challenge the previous high before it was slapped down. That move came this Wednesday. The market had a positive opened and it looked like it might make a run at the high. Instead, it made a key reversal and by the close the S&P 500 futures had lost 20 points. Thursday’s rally was a half-hearted and once the market was unable to add to Wednesday's decline, the buyers came in to shakeout the short sellers. Today the market is off to a weak start and I’m writing my comments an hour after the open.

Concerns over the Bear Stearns hedge fund bailout (exposed to sub-prime lending) are putting pressure on the market. Overnight, the Shanghai Index fell 3% as traders believe that a rate hike there is eminent. In the U.S., interest rates have been creeping higher and next week the FOMC convenes. I believe their comments will dictate stock prices for the next month. The Fed has already stated its bias favors an increase. Earlier in the year, traders were wondering when the Fed might ease, now they are wondering how long the Fed will hold off on a rate hike. This realization will be bearish for the market as traders adjust their models. Short-term, I am starting to think that the SPY 146 level will be tested soon. That will ultimately set-up a great buying opportunity. The market needs to get accustom to higher interest rates. Once it does so, all of the other pieces are in place for a continued rally.





The economic releases from this week were balanced. Slower housing starts were offset by an increase in building permits. A robust Philly Fed number showed the highest level of manufacturing in two years, however, manufacturer’s sentiment for the next six months fell to its lowest level this year. Next week will be filled with economic releases (Consumer Confidence, Durable Goods, PCE price index, Chicago PMI) but they will all take a back seat to the FOMC comments.

Two earnings releases are of particular interest next week (WAG, LEN, NKE, CAG, BBBY, MU, PAYX, RHAT, MON, RIMM). RIMM and MON have run up and we will see if they are able to meet raised expectations.

Given my longer-term bullishness, it will be difficult for me to short this market. The snap back rallies have been extreme and I don't want to get caught in any of them. I will adjust by reducing my long positions and by selling call credit spreads on stocks that I feel are weak. The retail and restaurant groups are strained and they will experience selling pressure for the next quarter. The key is to identify the underperformers in each group.

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Peter Stolcers

In the last two weeks we've seen a 50 point decline and a 40 point rally in the S&P 500 futures. Earnings season has passed and the market is looking for something it can sink its teeth into. It took seven years for the market to make a new all-time high. Despite a stiff resistance level, it was able to fight-off the first speed bump – a 15% decline in the Shanghai Index. That dark cloud may have passed as traders believe that the selling can be contained to China. However, interest rates were a different story and the market cracked.

Global economic growth is putting upward pressure on interest rates. Last week England raised its rates a quarter-point and this week Switzerland followed suit. That puts upward pressure on our interest rates and the 10-year yield went above 5%. Asset allocation models kicked in and the market went through a discovery phase. Selling pressure tested the “bid” to the market and it determined the appetite for equities amidst rising interest rates. The bulls won this round and the selling never really took hold.

Higher interest rates that result from a strong economy don't conflict with a bullish market. The latest rise in interest rates resulted in and a positively sloped yield curve and that is considered bullish. Wednesday, the Fed released its Beige Book. It is published every six weeks and it is a collection of economic activity from various regions in the US. It showed rising economic activity and moderate inflation. Once the numbers were released, the market rallied more than 15 S&P 500 points. The surge was created by buying, short covering, and expiration related buy programs. Thursday the market followed through on a benign PPI number. I'm writing this report a day earlier than normal so I will take a stab at Friday's action. I believe that the CPI will be in line with expectations. It might even be a little "hot". The market will look past the number and post modest gains. Most of the expiration related fireworks have passed and the afternoon could get quiet. “Merger Monday's” have been bear slayers and the shorts will not get aggressive going into the weekend.

This week the economic numbers are very light. They will be highlighted by housing numbers, leading economic indicators and the Philly Fed. Housing starts and building permits might shed light on that sector. From my perspective the numbers can only be bullish. So much gloom and doom has been factored in to housing that I doubt a bad number will weigh on the market.

Last week LEH and GS posted solid earnings but they failed to light a fire under financial stocks. I believe this sector is a sleeping giant and it may be the source of the next rally. Here are the major companies that will announce earnings next week; BBY, DRI, KMX, FDX, GIS, CC. The electronics, auto and restaurant stocks might shed light on the strength of consumers. However, I'm more interested in FDX and GIS. FedEx’s activity will be used to measure economic growth and General Mills will provide insights on food inflation.





Solid earnings, steady interest rates at the low end of the 50-year range, global expansion, moderate inflation, full employment and reasonable P/E ratios all point to a stable market. I am firmly in the “buy the dip” camp as long as the market is above SPY 146.

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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.

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Peter Stolcers

Last week was shortened by the holiday. Traders often struggle to get their bearings after a long weekend. The tone was set two weeks ago when the S&P 500 dropped 16 points on Thursday. Jitters going into the week were exacerbated Wednesday when the Shanghai Index dropped 6% overnight. A .2% increase in the stamp tax placed on Chinese stock trades was to blame. The media sensationalized the event by emphasizing that the rate had tripled. While accurate, it made the news seem bigger than it actually was. From a trader’s perspective, if I'm trading a parabolic market, higher margins or commissions or exchange fees are not going to impact my activity - especially when it only amounts to .2%. Our market opened lower and it looked like profit taking might set in. By mid-morning, prices stabilized and the stage was set for a huge intraday reversal. This pattern has been very pronounced over the last few months. The market has a big one day drop and then it reverses and surges higher. The take away from all of this is that the China "bubble" is factored into prices. That market has made a huge move and everyone is expecting a pullback of decent magnitude. It’s a "closed market" and judging from this week's reaction, the consensus is that the selling can be quarantined. This was not the same reaction we saw after the one-day 10% drop in February. The Chinese can change the rules of the game at a whim and that market is treading on thin ice.

As the week progressed our market digested economic numbers and it continued to make new all-time highs. The biggest move came on Friday’s Unemployment Report. Despite a .3% rise in hourly wages, the market pushed higher. Two months ago the reaction to wage inflation would have caused a sell off. That's because some traders still hoped for a Fed ease and that component of the release would have dashed their spirit. The market is growing accustomed to the Fed’s "tight light" bias. Now it's almost a matter of how long they will wait before raising rates. I believe interest rates will remain unchanged the rest of the year.






The week ahead is very light in terms of economic releases (ISM services, productivity, unit labor costs, wholesale trade, consumer credit, trade balance) and I don't see any of these numbers driving the market. When the earnings calendar is highlighted by stocks like GES, ZQK and SFD, you know it's going to be a quiet week.

Next week we can expect dull summer-like trading. There is no news to drive the market. We are past end-of-month fund buying and we are a week away from option expiration. The path of least resistance is up and until I see a breakdown with follow through, I will stay bullish.