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Ride The Last Leg of This Rally If You Are Nimble - Be Quick To Pull The Plug If You See This

Posted by Pete Stolcers on January 14

Posted 9:30 AM ET – There is not much overnight news and the market continues to float higher in an upward sloping channel. This pattern could result in a buying climax as mega cap tech stocks prepare to report earnings. An additional $500 billion in stimulus is also keeping buyers engaged. The dark clouds are mounting and swing traders looking to milk the last leg of this rally need to tread cautiously.

Big banks will kick off earnings season tomorrow and I believe that the upside is relatively contained since they have rallied hard in the last month. A weak labor market and historically low interest rates do not bode well for banking profits. The upside catalyst is likely to come from the tech sector. These giants have been relatively unaffected by the virus and profits should be healthy. At a P/E of 40, there are no bargains in the S&P 500 at this level.

Money printing will continue and this liquidity injection is keeping the market afloat. Realize that this is a “sugar high” that does not have a long-term economic benefit. This money will instantly be consumed and not invested.

Last week we saw job losses in both employment numbers (the Unemployment Report and ADP). This morning we learned that initial jobless claims spiked to 965,000 (795,000 expected). This is the highest number in months and the Coronavirus is taking its toll.

The virus continues to spread rapidly and there are a few new mutations in the US. We don’t know how effective the vaccines are on these new mutations, but most analysts believe that the vaccines will work. The vaccines will not have a material impact in the spread of the virus until May according to experts. This means that a sharp economic rebound in Q1 is unlikely.

A year ago a similar table was set. Investors completely ignored the significance of what was happening in China. They rationalized that the virus would come and go and that stocks would weather the storm. With interest rates at historically low levels generating negative real returns, stocks were the only alternative. Option implied volatilities were at historic lows and that was a sign that Asset Managers were unhedged. Bullish sentiment was also at record highs. This is exactly where we sit today. Long term investors who stayed the course had some nervous months, but their portfolios recovered. Swing traders who ignored the backdrop were wiped out.

Swing traders should mainly stay on the sidelines. Passively sell out of the money bullish put spreads that expire in three weeks or less on strong stocks. Time decay will constantly be working in your favor and you can distance yourself from the action. I believe that there are a few more weeks of bullish price action and we could even see a market melt up. This type of price action would prompt profit-taking and the backside could be very nasty as bullish speculators get flushed out. These moves happen in an instant and we’ve seen the S&P 500 dropped more than 100 points in a day. Use a close below SPY $370 as your stop for bullish positions. As we get into February, I plan to be in cash for my swing trades.

Day traders should enjoy the price action in hot stocks while it lasts. Option Stalker searches identify stocks with huge volume and big breakouts. These moves are sustained during the first half of the day and I suspect that part of the move is driven by short covering. Set your targets and take profits. As long as we don’t see a massive spike higher, I believe that the downside is relatively contained. The market barely flinched after the spike in initial jobless claims this morning. Support has been tested in the first half of the week and I believe that buyers will be a little more aggressive now that the bid has been confirmed.

Support is at SPY $377 and resistance is at $381.50.
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