Europe Is Back With a Vengeance

Dear Slingshot Trader Subscribers, 

Why do European problems affect domestic stocks? For that matter, why would problems in an extremely small European economy like Greece matter to North American traders? These are questions we get quite regularly. The answer is simple; Europe is tightly integrated with the United States, as one of our biggest customers (especially for financial services) and one of our most important vendors. In essence, the United States is running a corner-store that depends on the health of the global neighborhood economy to profit.

It’s not just about Greece either

If Greece could somehow be removed from the European Union to deal with its problems in isolation, that would be great. The emerging government in Greece this week is making demands that prior agreements for bailouts with the IMF and EU should be torn up. Past Greek governments over the last few years have withheld information or outright lied about the financial situation, and have refused to modernize the economy or tax collections. Greece has been sending louder signals over the last few months that they want out of the EU monetary union, and it seems the European’s would be better off without them anyway.

However, in the global economy, a new default by Greece and a flight from the European Union could trigger other dominoes. This includes Spain, Italy and the other so called “PIIGS” of the EU. For example, in the chart below you can see how this news has affected one of the largest Spanish banks – Banco Santander (STD), which dropped another 7% today to be under 2008 lows and nearly equal 2009 lows.

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Banco Santander (STD) – Chart Courtesy of MetaStock
 

The Greek crisis and default is an issue for Spain and Italian banks because it drives investors further into a “risk off” bias. Investments in Spain may not be as high of a risk as Greece, but they are much riskier than investments in Germany or the United States, so investors become motivated to move further up the chain to where they perceive greater safety. That flight of investors takes capital away from regions that need it most and can push them further towards a “Greek crisis” of their own.

Stability in the debt markets matters to stocks

The last two times we saw a significant disruption in the debt market in Europe was in July-August and late October of 2011. The October decline was similar to this one, because it was caused by recalcitrance on the part of the Greek government to live up to agreements it had made. The ripple effects of this disruption led to a 10% decline in the S&P 500. A similar correction right now would continue to push the S&P 500 down to 1,278.

As you can see on the next chart, this would push prices down to the 38.2% retracement level that is roughly equal to October’s highs before the last debt market crisis. This kind of symmetry is impressive but not unusual. There is little doubt that an escalation of the crisis in Europe is very likely, so a decline like this seems reasonable.

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S&P 500 – Chart Courtesy of MetaStock
 

Is this the end of the bull market?

We would suggest that this isn’t the end of the bull market, but the likely start to the so-called wave four of a bull rally. The chart below lays out what we expect for wave four, and the subsequent potential for wave five. This is a form of analysis that has been useful in the past, to understand market sentiment in a choppy trend, and has been reasonably reliable. Although the potential for summer gains still looks good, the short term is almost certain to be choppy and bearish.

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S&P 500 Elliott Wave – Chart Courtesy of Metastock
 

One significant caveat we would make to this analysis is of course – Europe. If the European crisis worsens much more than expected (which is already pretty bad) then prices could fall much lower.

The bottom line for this week

The market looks bad today, and it is probably going to get worse in the short term, which is the time frame we are almost always trading. That will put an emphasis on bearish news. In conditions like this, we expect that a negative surprise will move a stock further down than a very positive surprise will move a stock up. We expect this to be our bias while the S&P 500 works its way down to support or the end of “wave four” outlined above.

There is one significant wildcard that could turn things around faster than we expect. It seems unlikely, but the last couple of times the debt market has really been disrupted the Fed has stepped in and calmed things down. In late November 2011 they opened swap lines with banks in Europe, and in September of 2011 they turned it around with the launch of Operation Twist, a bond buying program.

If the Fed were to intervene like that again, we could take advantage of it with a trade like we did last time. The news isn’t always bad when we can spin it back around into a new opportunity.

Here are some of the news events that we may trade in the next week or so. We’ll be discussing some of these in tonight’s webinar.

May 9 – Chinese Trade Balance

May 9 – Cisco (CSCO) earnings – after market

May 10 – Bank of England interest rate statement

May 10 – Express Scripts (ESRX) earnings – after market

May 10 – Nordstrom (JWN) earnings – after market

May 11 – University of Michigan Consumer Sentiment

May 15- U.S. Core Retail Sales

May 15 – Home Depot (HD) earnings – before market

May 16 – Deere (DE) earnings – before market

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 portfolios here. You can also see more trade-specific details by clicking on the trade links below.

Open Positions

These are the SlingShot Trader positions we opened during the past two weeks of trading that we have not yet closed.

Express Scripts (ESRX) – On May 8, we recommended you to “buy to open” the June 52.50 Puts (ESRX120519P00052500) for $2.00 or less. We still like this trade and recommend entries at our maximum price or less.

Nordstrom (JWN) – On May 7, we recommended you to “buy to open” the June 57.50 Calls (JWN120616C00057500) for $1.20 per share or less. Although we still recommend this trade – the price has moved considerably and it is a very high-risk position for new entries.

Silver Wheaton (SLW) – On May 9, we recommended you to “buy to open” the June 25 Puts (SLW120616P00025000)  for $0.73 per share or less. We still like this trade and recommend entries at our maximum price or less.

Positions Closed

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

Molson Coors (TAP) – On May 8, we recommended you to “sell to close” the June 40 Puts. We closed the position for $.86 per share for a gain of 23%.

Clean Energy Fuels (CLNE) – On May 4, we recommended you to “sell to close” the June 18 Puts. We closed the position for $1.88 for a gain of 50%.

Manpower (MAN) – On May 4, we recommended you to “sell to close” the June 40 Puts for $2.18 per share for a gain of 51%.

Youku (YOKU) – On May 4, we recommended you to “sell to close” the May 22 Puts for $.88 per share for a loss of -4%.

Green Mountain Coffee Roasters (GMCR) – On May 3, we recommended you to “sell to close” the June 45 Puts for $15.36 per share for a gain of 309%.

Prudential Financial (PRU) – On May 3, we recommended you to “sell to close” the May 62.50 Calls for $.02 per share for a loss of 98%.

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’ll 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.

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