Banks Will Make or Break the Trend

Dear SlingShot Trader Subscriber,

There is a good chance that resistance will hold on the major indices for the next week or two, at least. Traders are starting to think about earnings again and trying to position for the kick-off on Jan. 9 with Alcoa (AA) reporting after the market closes. This report is the traditional start to the quarterly season but reports are already starting to pick up this week.

So far, there haven’t been enough actual data to draw any conclusions about earnings season but average analyst expectations are a little soft. This is probably not the best way to head into January while Italian bond yields continue to hover near 7% for the 10-year note. This is a related issue to the news from the banking sector that we expect will dominate this season.

Although Alcoa kicks off earnings-season, we expect that traders will be much more interested in the results from the financial sector. For example, according to The Wall Street Journal, analysts expect that Bank of America (BAC) will be the source of 14% of the S&P 500’s total earnings growth in 2012. That is a lot of weight to put on the shoulders of a firm with an astonishingly large swap exposure to the European debt crisis.

Unfortunately, the big banks, including Bank of America, don’t start reporting until the middle of January so we will have to wait a while to get a better estimate of first-quarter prospects. Bank of America will report on Jan. 19 and is preceded by Citigroup (C) and Wells Fargo (WFC) that same week. This delay is one of the most important factors we are using to forecast whether resistance will hold on the S&P 500 this week and next.

The chart below is a good illustration of the point we are making. Bank of America has a strong positive correlation with the broader indices, however it will diverge periodically. This happened in mid-summer of last year, which eventually contributed to the subsequent collapse in equity prices in August. Since that time, both charts bottomed out in October, but Bank of America has continued to set lower lows.

S&P 500 (Green & Red), Bank of America (Black & White): Chart Courtesy of Metastock

That divergence is telling us that here is a lot of drag on equity prices. We wouldn’t go as far as to suggest that prices will collapse again like they did last August, but it should help illustrate why expectations for Bank of America’s earnings are so high. If these expectations are already priced into the stock, then a disappointment would be a big problem for the broader market.

Following the Bank of America report, we will start to look for confirmation from the smaller regional banks. Regional banks have outperformed many of the larger money-center banks over the last few months, and they are a good proxy for growth in the broader economy. These firms can be much more sensitive to business lending conditions, defaults, and profit growth than the larger banks.

For example, you can see another similar chart below that compares KeyCorp (KEY) to the S&P 500 where the correlation has recently been much stronger than it was with Bank of America. However, in percentage terms, even the regional banks have lagged the broader market and are currently hovering near very strong long-term resistance levels.

S&P 500 (Green & Red), KeyCorp (Black & White): Chart Courtesy of Metastock

When the short-term prospects for stocks are concentrated on a single industry like this, traders get a little nervous and are quick to take profits and look for hedges. During the last several months or so, we have followed the same strategy by not allowing trades to run too long. Although this is an effective strategy in a market like this, a trending market can be much better.

The Bottom Line for the Next Seven Days

This peek into fourth-quarter earnings season is not all bad news. The only thing we are really counting on is that resistance is likely to hold through most of January until bank reports start streaming in. That means that we still have a mild bias to the downside (and will be trading that way) but we want to stay flexible as earnings news begins to pick up. Although there is a lot riding on the big bank reports, you shouldn’t assume that they can’t surprise to the upside.

A positive earnings surprise is not as much of a stretch as it may sound. It happened a few times in 2009 and 2010, which led to large rallies over several months, and it could happen again. The best strategy in a market like this is to be prepared for sudden shifts and surprises that can be very common. Although our outlook for the next two weeks is leaning toward bearish, we plan to keep holding periods as short as possible.

We are also expecting this week’s labor reports to make a big impact on stocks. With downward pressure on the markets coming from Europe and emerging markets, theU.S.labor market needs to see stronger growth in 2012 than it did in 2011 to sustain an uptrend. A single announcement can only give us so much information, but it could get traders started on the right foot if more jobs are added than had been expected.

This Week’s Events

As we’ve noted, earnings releases will really being to ramp up toward the middle of January, but there are a few key reports with Alcoa and the banks in the coming days that may help create new trading opportunities. We’ll discuss these in more detail during today’s weekly webinar at 6 p.m. ET.

01/04 – Mosaic (MOS) Quarterly Earnings – After Market Close

01/05 – ADP Unemployment Report – Before Market Open

01/05 –  Apollo Group (APOL) Quarterly Earnings – After Market Close

01/06 – BLS Unemployment Report – Before Market Open

01/09 – Alcoa (AA) Quarterly Earnings – After Market Close

TRADE REVIEW

When it’s time to open or close a trade, we’ll send you alerts via e-mail. You also can sign up to receive text messages regarding our trades. For more info about our SlingShot Trader portfolio, you can read trade alerts here and view our portfolio here. You also can see more trade-specific details by clicking on the trade links below.

Positions Opened

These are the SlingShot Trader positions we opened during the past week of trading and haven’t closed yet.

Apollo Group (APOL) – On Jan. 3, we bought to open the Apollo Group (APOL) Jan 50 Puts for $1.35. We still like this position if it can be opened at our entry price or less.

Mosaic Company (MOS) – On Dec. 29, we bought to open the Mosaic Company (MOS) Feb 45 Puts for $1.58. We still like this trade and it can be opened for less than our original price.

Positions Closed

These are the SlingShot Trader positions we closed during the past week of trading.

Cal-Maine Foods (CALM) – On Dec. 27, we bought to open the Cal-Maine Foods (CALM) Feb 35 Puts for $1.25. We closed the position on Dec. 30, for 93 cents per share.

Top Trades Now

These are the current SlingShot Trader positions that we still recommend getting into now, assuming you haven’t already bought a full position.

Apollo Group (APOL) – On Jan. 3, we bought to open the Apollo Group (APOL) Jan 50 Puts for $1.35. We still like this position if it can be opened at our entry price or less.

Mosaic Company (MOS) – On Dec. 29, we bought to open the Mosaic Company (MOS) Feb 45 Puts for $1.58. We still like this trade and it can be opened for less than our original price.

Webinar Preview: Join Us Tonight at 6 p.m. ET

Every Wednesday at 6 p.m. ET, we host our live webinar, in which we’ll review this weekly newsletter, discuss coming events in more detail and walk through our Top Trades. We also encourage you to submit your questions live during the session. We want to do everything we can to help you become a successful options trader, which is why you have live access to us for an hour every week.

And if you have any questions or comments you would like to send us in advance of the live session — or anytime during the week — you can write to us at johnandwade@slingshot-trader.com. (Please send any questions about the status of your subscription directly to Customer Service at service@slingshot-trader.com.)

If you can’t attend the session live, you can watch the archived version on our website in the “Live Weekly” section. It’ll typically be posted within about two hours of the end of the live session.Sincerely,

 

John Jagerson and Wade Hansen
Editors
SlingShot Trader