Intraday comments focus once again on Market Direction. The market direction remains of concern. Yesterday’s big jump which pushed the S&P 500 index to above the 200 period moving average is showing just how much resistance there is now to stocks climbing higher in value.
This rally is not over but there will be resistance every step higher and longer term the S&P 500 is showing that without substantial earnings increases the market cannot sustain higher prices.
Don’t misunderstand. There is room on the upside and stocks may even try to break the 50 period moving average, but the trend now is lower moving out longer term. Months ago I mentioned that earnings in 2010 rebounded sharply from 2008 to 2009 which spurred the market to higher gains. Earnings were good in 2011 but not as good as 2010. Ion 2012 earnings began to drop mid-way through the year and are now showing weakness across the board.
Market Direction Is Always About Earnings
At the end of the day, it is earnings that can propel stocks higher. The S&P 500 stocks must jointly show a growth of about 15% to keep the index at present levels. Without that growth the index will eventually pullback to a more sustainable level. No matter whether there is a fiscal cliff or a solution, increased taxation in any form means less growth as 70% of the economy is tied directly to consumer spending. If they have less to spend then the economy won’t grow. If the economy does not grow then business cannot earn more and more earnings is what stocks need.
Put Selling Is The Strategy
This kind of market bodes well for Put Selling but for investors who do not want to own stocks you must wait for upticks or for a stock to show support and some strength before selling puts and you must always stay out of the money.
For those investors such as myself who would own some great companies, Put Selling is my strategy of choice because as the market deteriorates I earn substantial put premiums and eventually I can end up owning shares at very attractive prices. In particular, the Put Selling Ladder works very well in this kind of environment. By continually selling puts lower and lower as stocks fall, and keeping put contracts size small to not tie too much capital, I eventually end up owning shares at low prices.
Stocks Are Not Cheap
Don’t fall into the trap of thinking stocks are now cheap after the recent pullback. Only certain stocks are cheap but most remain overvalued. The recent correction has moved the S&P back to the 2007 correction before the market rushed higher to put in a top. Stocks were very overvalued even during the 2007 correction, so make no mistake, stocks in general are still overvalued now. Earnings on most stocks were better in mid 2007 than right now and the earnings outlook actually appeared brighter back in early 2007. Right now they are downright gloomy. Everything from market breadth and volumes to earnings are eroding. The momentum is moving away from stocks climbing further into 2013.
There are three prices on stocks. Regular, cheap and fire sale. The chart below shows where prices are cheap, where the fire sale was and why they are NOT CHEAP now. The 2006 pullback marked the retrenchment before the 2007 run-up in stocks and the 2006 correction ended when stocks fell to where most were fairly valued but in that correction they were not cheap.
So be careful when selecting put strikes for selling against stocks. Look to get into stocks cheaply even if it means selling leap puts far out of the money at strikes that are realistic.
Market Direction and Why Stocks Are Not Cheap Now
Market Direction Intraday
Intraday, the market direction has disappointed. I believe the market will move higher into the close but today had a very poor follow through. There is no reason to expect that this rally is a new leg higher in the markets. While it will move higher from here, watch MACD for any signs that the market direction is truly changing. I doubt market direction will be confirmed by the MACD technical timing tool as moving back up. This is a market direction rally and should be traded as such. Stay cautious, keep cash back for opportunities and stay with strategies that offer returns but also some degree of protection. I do believe 2013 will be a tough year on stocks.