Dear SlingShot Trader Subscriber,
We found last night’s good news about China reaffirming its willingness to back European debt very interesting. Besides being a little vague, it was nice to hear, but it also brings attention back to a different unresolved issue the markets are dealing with – growth. Over the last few years, growth has been a problem for the economies that the world is leaning on to put the credit crisis behind us. Traders are a little undecided about growth in the United States, but today’s negative GDP data from Germany indicates Europe’s economy is sliding into recession again.
China should be right at the top of the list of growth concerns. While it is certainly nowhere near negative growth like Germany, it has been slowing, and that can put a lot of pressure on the global economy. It’s great that they want to back bad European debt but, economically speaking, they aren’t out of the woods themselves. One of the places we can see the impact of slowing global-growth is in the price of commodities. Unlike finance, technology, industrials, and cyclicals, commodity-stocks and prices have lagged the recent breakout and refuse to confirm a potential breakout above resistance on the S&P 500.
In the next chart, you can see copper futures prices (red and green candles) that have been paused since the end of January at resistance based on 2011 support levels. We also applied a chart of the S&P500 (black line,) so the divergence we are observing would be more clear. The shift is subtle, but clearly copper buyers are not convinced that growth will continue to drive prices, and this is in conflict to the short term trend in stocks. This issue is not just about copper, but because it is very sensitive to changes in large construction and manufacturing projects, we used it to stand in for commodity prices on average.
A divergence like this emerged in April and October of 2011, just before stocks sold off and began to follow copper prices. As you can imagine, there are many factors at play in both of these markets and the correlation will never be perfect, but the divergence that exists between stocks and commodity prices indicate a weak trend. Either market could break out to the upside again, but history has shown that stocks will more often correct in favor of commodity prices not the other way around.
Changes in growth trends take a long time to reverse. For example, since December of 2009, Chinese manufacturing PMI (PPMIQ.PK), a sentiment indicator, has been in decline. Recently, that decline has started to accelerate, with a big miss at the end of October 2011. You can see how that disappointment kicked off the most recent divergence between copper (and other commodities) and stocks in the previous chart.
Chinese manufacturing PMI shows us how optimistic purchasing managers at factories are about economic conditions in the near term. The next report is due at the end of February, and current prices are pointing to a potential disappointment. Will the current decline pull stocks back down? And if so, how far are they likely to drop?
It’s always a risk writing something like this that sounds “bearish,” but really could be leading towards a small adjustment in stock prices while the major asset classes catch up with each other rather than a full collapse. In fact, a pause at this level on the S&P 500 would be normal compared to prior rallies, and a decline to support established in October and November of last year would be expected. In the next chart you can see what this looks like from a technical perspective.
Based on the rally from the bottom of the market in October to the current level of resistance on the S&P 500, we would expect that there is a high probability for a pullback to 1290, which is technical support (established last October) and it neatly lines up with the 23.6% retracement level. If a bounce were to occur at that level, the subsequent rally would be expected to break resistance and establish highs above 2011 prices.
Stocks are pausing at resistance, and the most recent move up has lacked confirmation from commodity prices (not to mention bonds), which indicates a weak trend. Some profit taking at this level would be expected, and could drive stocks flat or down for a few weeks at a minimum. It is certainly possible to see higher stock prices without a draw-down, but the likelihood for such a move is dropping more each day.
At Slingshot Trader, we trade based on upcoming news. When the market is bullish, we look for stocks that are expected to beat expectations and will rally because there are buyers in the market. When the first part of that turns out to be true, but buyers do not emerge — take Zynga (ZNGA) and Deere and Company (DE) as prime examples – it signals the potential for change. In the short term, we would expect to be looking to add a few more trades to our list where we anticipate the potential for a disappointment that we can profit from with put options.
This Week’s Events
Earnings are still in play this season, and haven’t been great, but not bad either. Economic reports have continued to look relatively good, with a few disappointments that could turn the trend. Greece remains an issue, but so far traders seem confident that the future debt settlement is priced into the market. We expect earnings to continue to add to market volatility for the next week and we plan to look for trades that are bearish as well as bullish in the short term.
Feb. 16 – Apache Corp (APA) Earnings – Before Market Open
Feb. 16 – Duke Energy Corp (DUK) Earnings – Before Market Open
Feb. 16 – Philly Fed Manufacturing Index – 10:00AM Eastern
Feb. 16 – Nordstrom (JWN) Earnings – After Market Close
Feb. 21 – Home Depot (HD) & Wal Mart (WMT) Earnings – Before Market Open
Feb. 22 – German and French Manufacturing PMI – Before Market Open
When it’s time to open or close a trade, we’ll send you alerts via email. 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.
These are the SlingShot Trader positions we opened during the past week of trading.
Feb. 8 – Buy to open the ZNGA Mar 14 Calls for a maximum price of $1.40
Feb. 13 – Buy to open the DE Mar 90 Calls for a maximum price of $2.08
Feb. 14 – Buy to open the Apache Corp (APA) Mar 110 Calls for a maximum price of $2.80
These are the SlingShot Trader positions we closed during the past week of trading.
Feb. 9 – Sell to close the AKAM Mar 35 Calls for $3.90. Originally purchased for $1.82.
Feb. 15 – Sell to close the DE Mar 90 Calls for $0.93.
Feb. 15 – Sell to close the ZNGA Mar 14 Calls for $0.70.
Top Trades Now
Feb. 14 – Buy to open the Apache Corp (APA) Mar 110 Calls for a maximum price of $2.80.
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John Jagerson and Wade Hansen