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Short the SPY Below This Level. Downside Risk Greater Than Upside Reward

Posted by Pete Stolcers on July 24

Posted 9:30 AM ET – This week we will get a broad sampling of earnings. So far the results have been good, but not good enough to fuel the market to a new high. The overnight reactions were positive. Face-to-face trade negotiations with China will resume Monday and stocks rallied on the news yesterday. Global economic conditions continue to soften, but investors are not concerned.

Texas Instruments posted a strong number yesterday and the stock will fuel semi-conductors today. Mega cap tech stocks are down slightly overnight as the Department of Justice launches antitrust investigations. Facebook reports after the close today and a good number could negate these concerns. Stocks are trading at a lofty forward P/E of 17 and fantastic results are expected. Roughly a quarter of the S&P 500 companies will report this week. Earnings season will climax next week.

US/China trade negotiators will meet face-to-face on Monday, but the enthusiasm is low. Since the G20 meeting a few weeks ago all negotiations have been held by teleconference. This is a sign that it is not worth anyone’s time to get in a plane. We will not see a trade deal before the 2020 election, but the market doesn’t seem to care. China will try to reduce costs (subsidies and currency devaluation) to make their products more competitive and consumers might not feel much of a pinch.

Manufacturing flash PMI’s were soft overnight. Europe and Japan are well into contraction territory (below 50). Germany’s flash manufacturing PMI was a miserable 43.1. The ECB statement tomorrow should be extremely dovish and that is keeping the market afloat. It is important to note that the ECB is out of “bullets”. Interest rates are already at 0% and all they can do is postpone future rate hikes. Quantitative easing has not helped.

Domestic economic numbers are strong, but drifting lower. This Friday Q2 GDP is expected to come in at 1.8% vs 3.1% last quarter.

The market rally is fueled by global money printing (central banks are easing). Interest rates do not keep pace with inflation so bond investors lose purchasing power (negative real return on investment). Consequently, money is flowing into equities and investors are pushed out on the risk curve. That is the only way to generate a return. Money has to go somewhere and there are fewer shared due to corporate buy backs. Barring a credit crisis, the market bid will remain strong at the major moving averages.

Swing traders should remain sidelined. The upside reward is smaller than the downside risk. If the SPY closes below $295 we will take a partial (half) short position. Earnings season has to be spectacular for the market to move higher and the strongest companies report early in the earnings cycle. If the market can’t breakout to a new high in the next 10 days, it will retrace.

Day traders should look for early shorting opportunities today. Patiently wait for support and then buy stocks with relative strength. I will be watching post earnings plays and I will focus on stocks that are breaking out after a good number. Early market weakness will keep a lid on these names. It’s important not to be early, make sure that market support is established. If by chance the market has a down trend day, this strategy will not work. I do not want to see a new low for the day after two hours of trading. SPY $298 and $297 are minor support levels.

I’m still expecting a decent market bid for a week. Mega cap tech earnings will have been reported a week from now and the FOMC statement next Wednesday could have a major impact.
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