The Pain in Spain Stays Mainly in the Yields

The Pain in Spain Stays Mainly in the Yields

Dear Slingshot Trader Subscribers, 

Two weeks ago, we mentioned the growing financial problems in Spain. On Wednesday of this week, those problems captured headlines, when Spanish bond yields hit new highs. The highest rate of interest (so far) that the Spanish government will have to pay on their 10-year bonds is 6.75%. That number sounds alarm bells for two reasons.

First, this essentially equals the highest rate Spain has ever had to pay since it joined the Eurozone (yields briefly hit 6.77% last November). This means investors think the problems Spain faces in paying its bills are worse than ever—and they probably are. Take a look at this updated chart for Banco Santander (STD), the bank we wrote about two weeks ago. The price is nearing the lows it traded at during the 2008 financial crisis.

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Banco Santander (STD) – Chart Courtesy of MetaStock
 

Second, 7% is considered by most analysts as the edge of a financial cliff—one that Spain is dancing ever closer toward. We know that 7% may seem like an arbitrary measure, but the conventional wisdom is that if a country must pay that much interest on its bonds, then the country’s tax base will eventually have trouble generating enough revenue to cover the obligated payments on those bonds. So at 7%, investors have begun to price in the possibility that they will lose some of their money to a default down the road.

In fact, if you do some quick math, you’ll find that at an interest rate of 7.2%, 10-year bond holders double their money when the bonds reach maturity. So as an investor, if you thought a government was going to give you a write-down of 50% on your money, you’d be fine with that so long as you captured six years of interest at 7% or higher. That’s how we can see that investors demanding that much interest are actually preparing themselves for at least the possibility of default.

Rising interest rates are simply a gauge of exactly how much investors are worried that the Spanish government will actually default on its debts, but it illustrates just how the anti-risk mood of the markets in general in persisting. Considering that whatever solution is reached to stabilize the Eurozone will take weeks (if not months) to unfold, we believe the risk-averse mood we are seeing in the international market will persist throughout the summer.

The U.S. Government a.k.a. Jobs Inc.?

This week, the U.S. Non-Farm Payroll (NFP) report comes out. If there were any possible tonic for the mood of this market, it would probably be eagerly found by pundits touting the job-creating capacity of the largest economy on the planet. There would be no shortage of headlines to that effect if the NFP report produced surprisingly better than expected results, but don’t count on it. For the last two months, this report has come in well below forecasts. Yet while the current forecast is lower than last month’s target, it is still higher than last month’s actual (see figure).

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Non-Farm Payroll report – Chart Courtesy of Forex Factory
 

So if the report actually turned up with the forecasted number, it would show an increase of jobs when comparing last month to this month. With summer only just getting started, it seems unusual to think that a sudden burst of jobs will come out of nowhere. It may not be crazy to expect the jobs number to disappoint the third time around. If it does, the major market indices will likely take out their old lows.

One Shiny AAPL in the Barrel

A more optimistic way of looking at things begins with considering that one stock notably held its recent gains. Apple Computer (AAPL) surprisingly did not participate in Wednesday’s sell off. AAPL is important because it is a highly weighted component of both the S&P 500 and the NASDAQ 100. For that reason, a strong showing by AAPL can sometimes single-handedly move the rest of the market higher.

Since AAPL was trading positive while the major indices were shedding more than 1.5%, it’s a good sign that demand for the stock remains strong at its current price levels. If the NFP report were to be surprisingly favorable, AAPL would likely shoot higher, and the indices would then form an interesting support base from which to build on as we move into our next earnings season.

Is This the End of the Bull Market Correction?

We would suggest that while the downtrend in stocks looks more likely to continue than not, the chart below shows two possible scenarios. The first shows that if the market breaks through its current lows, the bearish mood will most likely continue. The second shows that if the market breaks above its recent highs, the bullish trend may resume in the near future. We are watching both levels closely, and will react accordingly in our portfolio.

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S&P 500 – Chart Courtesy of Metastock
 

The Bottom Line for Next Week

The market looks nervous today, and it may not be pricing in bad news that will come later this week. The emphasis remains on bearish news. Negative surprises are becoming more commonplace, however, and it is possible that a positive surprise might bring a rapid rebound, where negative surprises may have already been priced in to the market.

This Week’s Events

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 30 – TiVo (TIVO) Earnings Announcement (After market close)

May 31 – ADP Non-Farm Payroll

May 31 – U.S. Gross Domestic Product (GDP)

June 1 – U.S. Non-Farm Payroll

June 1 – PMI Manufacturing Index

June 1 – ISM Manufacturing Index

June 4 – Factory Orders

June 5 – ISM Non-Manufacturing Index

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 SlingShotTrader portfolio, you can read trade alerts here and view our portfolios here.

 
Open Positions

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

Tivo (TIVO) — On May 25 we recommended you to “buy to open” the June 9 puts for $0.45 per share or less. We still like this trade and recommend entries at our maximum price or less.

Goldcorp Inc. (GG) – On May 29 we recommended you to “buy to open” the July 37 puts for $2.10 per share or less. We still like this trade and recommend entries at our maximum price or less.

Closed Positions

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

Youku (YOKU) – On May 18 we recommended you to “sell to close” the June 22 puts. We closed the position for $2.51 per share for a gain of 38%.

Foot Locker (FL) – On May 18 we recommended you to “sell to close” the June 28 puts. We closed the position for $0.40 per share for a loss of -61%.

Best Buy (BBY) – On May 18 we recommended you to “sell to close” the June 18 puts. We closed the position for $1.31 per share for a gain of 38%.

Pandora (P) – On May 24 we recommended you to “sell to close” the June 10 puts. We closed the position for $0.15 per share for a loss of -89%.

H.J. Heinz Company (HNZ) – On May 24 we recommended you to “sell to close” the June 55 puts. We closed the position for $2.07 per share for a gain of 25%.

Tiffany & Co. (TIF) – On May 24 we recommended you to “sell to close” the June 65 calls. We closed the position for $0.07 per share for a loss of -95%.

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