Watch How Investors React to Budget Cuts

Thursday – Notes & Research

The day the Sequester became real… new at eleven. I feel like I am watching an old commercial for the nightly news as the media hypes the budget cuts of $85 billion. They act as if this is 50% of the total budget versus 2%. The cuts are not ideal by any stretch, but some spending cuts are better than none. The two bills were rather interesting to say the least. But, the proposal to use alternative spending cuts and again raising taxes further on the rich! I will take the cut the way they are going to come down on this vote.

What does that mean to the market looking forward? The chart below is the intraday five minute chart of the S&P 500 index. Guess where the failed votes in the Senate were announced. That is correct… where the white horizontal line is drawn. While the decline was only 0.5%, it is the message of what we may see tomorrow as follow up to the news on the budget cuts taking place.

5 min

I am sticking with my views and continue to dig in to gain some insight into the current activity. This is not the kind of market I like, nor do I like the risk of this environment. The following are my key concerns:

  1. How do investors accept the budget cuts, assuming no deals are cut. The hype is leaning towards selling and I am not convinced that is the case after the initial reaction. Still looking for some downside of 1-3% in response, but then there will be a shift to the current data as the cuts don’t go fully in effect until September.
  2. What will the Fed do at the March FOMC meeting. No real changes expected to QE infinity, but will they shorten the timeline or adjust any method of delivery. Any changes will prompt a reaction.
  3. Can the economy really recover? Earnings grow? Revenue increase? Simple thing that make the market more palatable to investors.
  4. Will Europe be a problem for global markets as they unwind the issues in Italy, Ireland, Spain, etc? This is going to be a touchy subject across Europe short term.

Today brought some reality to what may be in store for tomorrow. It is important that we are willing to be patient and let the volatility play out short term. This could get even more interesting than it already is.

Economic Data:

The focus is now on the budget cuts of $85 billion. Analyst agree the cuts will have an impact on the economy over the longer term and could cost up to 1 million jobs. In the end only time will tell, and more is made of these issues than ever really materializes.

Despite the cuts some positive news from the

Data Summary

  • Weekly jobless claims were down 18,000 which continues to improve.
  • GDP was revised to a positive 0.1% versus the -0.1%… at least it is positive.
  • Chicago PMI was up to 56.8 versus the 55.6¬†announced¬†last month.
  • Durable goods orders drop 5.2%, but without transportation they actually grew by 1.9%. That news helped push the broad markets higher on Wednesday.
  • Pending home sales rose 4.5% versus the decline of 1.9% last month. That helped the homebuilder stocks move up 2.1% on the day. On Tuesday New Home Sales were 437,000… 53,000 ahead of expectation. Two positive reports for the housing sector after a disappointing January.
  • Consumer confidence jumped to 69.2 following a 58.4 reading in January. Nice jump for the consumer.

Economy is steadily treading water with little to no growth as the GDP report bears witness to. The short term outlook for the economy is positive, but just barely. Keep your focus and remain disciplined relative to your stops and exit points. Correction anyone? Famous last works from last week.

1) US Equities:

Market Summary:

  • Headlines Trumpet fourth month of gains as February closes. Watch out for the “Winds of March”!
  • Is the Dow setting up investors for a drop? The index came within 15 points of the high on Thursday before closing lower? Watch the trap that the index is setting up.
  • Groupon fired the founder relative to the missed earnings and lower revenue guidance. The stock fell 24% on the earnings miss and rallied after hours 3% on the firing.
  • S&P 500 index held on barely to the 1515 level on Thursday and the worries begin over no deal on budget cuts. We will continue to take this one day at a time.

Technical Outlook:

  • Broad index failed to hold the key support of 1495 for the S&P 500 index was broken on Monday. That changed yesterday and today as the index moved back above the 1515 level was recovered and leaves the question of direction still in play from my view.
  • NASDAQ, S&P 500 and S&P 600 are all holding their uptrends off the November 15th lows. That is a positive technically for the broad markets currently.
  • The markets are at a crossroads short term and watching the support and trend lines is key to determining the outlook short term.

Leadership Opportunities:

  • Still watching XLB, XLY and XLP on the bounce off support.
  • Healthcare is still on our radar for the upside and worth watching if the reversal builds any steam.
  • Look for technology and financials regain some leadership if the upside trend is going to hold.

Short Opportunities:

  • Two day rally has taken many of these off the table, but you still have to watch the bonds. TLT or the inverse TBT could set up a short term opportunity. Below I discuss the paired trade of long IEI and short TLT on the outlook that interest rates will rise longer term.
  • Watch commodities not acting well here, but if the dollar weakens on a equity rally you have to look at the short dollar, long commodities trade.
  • Telecom has moved lower to support on IYZ and could offer an opportunity on the downside with a break lower. $23.80 is level to watch.

December 28th Pivot Point for uptrend following the Fiscal Cliff pullback test. Watch the bounce of the newly minted low on 2/25.


November 15th Pivot Point for current uptrend. Target 1550-1575 short term. The uptrend off the November low remains in play,  but the downside attempting to take over the up trendline.


Tracking Sectors of Interest:

Telecom РThe DJ US Telecom index has pulled back, but the defensive nature of the stocks offers some opportunities at the stock level. We have been tracking both AT&T and Verizon as a dividend/growth idea.

  • WATCH: T – Break above resistance at $35.65 is attractive on the upside, plus the 5.1% dividend.
  • WATCH: VZ – Looks just like T on the consolidation and resistance $42.85, plus the 4.6% dividend. The stock has broken above resistance at the $44.80 level and moved higher.
  • Both stocks have moved higher with VZ showing the strongest move. Watch the risk of the trade.

Technology РThe trading range remains in play and holding support.

  • WATCH: GOOG – some consolidation at the high. Watch for move higher short term.
  • WATCH: HPQ – in our model and moved higher on earnings. Raise stop and watch for opportunity to add to the position on any pullback. The test of support at $19 held and has now continued higher.
  • WATCH: SOXX – the semiconductors need to lead the sector. $57.30 support needs to hold. Moving back towards the current high.

Financials РHit our stop, but still looking for the upside opportunity in the sector. The sector should still benefit on the upside if we and when the volatility dies further.

  • WATCH: KBE – banks are being driven by those with extensions into the brokerage business. BAC, C, MS, JPM and GS. Attempting to bounce back, but still have to watch how it plays out short term.
  • WATCH: IAI – sub-sector play on the brokers.

2) Currency:

Sector Summary:

  • The currency landscape is shifting short term to dollar strength, weakening euro and possible bounce in the yen short term. Small reversal on the day – exited our play on the dollar and short euro today.
  • FXB – the British Pound has dropped to $150.50 support level? This is a new near term low for the Pound. However, the $149.90 close is now lower.
  • FXC – the Canadian Dollar continued lower as well heading towards support at $95.35.

Tracking Currency of Interest:

US Dollar РThe buck rallied back and closed higher at $22.37. Watch support at $22.20 level, if it breaks look at a downside play.

Euro РThe euro (FXE) bounced off the support at $129.50 and ready to break above the $130.50 resistance level short term. Watch for upside opportunity if this holds. Reversed on Thursday and the downside resumed.

3) Fixed Income:

Sector Summary:

  • Yields continue are shifting slightly on the turmoil in stocks. ¬†The question is if the market corrects how much will it impact? We are in the process of finding out now.¬†
  • 30 Year Yield = 3.09% – down 1 basis points — ¬†TLT = $118.51 up 22 cents
  • 10 Year Yield = 1.88% – down 2 basis points — IEF = $107.16 up 15 cents

Tracking Bond Sectors of Interest:

Treasury Bonds РReversing again on the rally in stocks.

I am starting to like the long IEI vs the short TLT paired trade longer term. Working on the idea of the trade currently.

High Yield Bonds РHYG = 6.55% yield. Support held at $92.75. Let it run as investors remain in love with junk bonds.

Corporate Bonds РLQD = 3.8% yield. The price has found short term support ($118.90). Broke above resistance at the $119.50 level and the entry or pivot point. Follow through on the move higher Monday. $120 stop.

Municipal Bonds РMUB = 2.8% tax-free yield. The price of the bonds continue to move sideways. Found support and bounced back, but still looking for direction. Willing to wait for the right opportunity on the bonds.

Convertible Bonds РCVRT = 2.7% yield. Price had been moving higher on the current rally in stocks. The reversal pushed the bonds lower short term.

4) Commodities:

Sector Summary:

  • Bounce in gold reversed after a move to $156.17 on GLD . Down 2% last two days and back at $153. Still an issue with the downside short term. Watch as the short set up with GLL is back on the table.
  • Crude flat on the day, but still down following the selling on Monday. Closed below support of $93 — Watch downside? Closed at $92.85.
  • Copper was down 5.3% last week and is testing support at $44.58. Watch to see if the bottoming over the last three days plays out on the upside. NO – the downside risk still in play.
  • DBB bounce some support at $18.60 again. Didn’t work downside back in play
  • Commodities remain weak with the dollar adding to the pain short term.

Tracking Sectors of Interest:

BAL РA trading range of $52.80-54.40 is in play. A break higher would be a continuation of the move off the November lows. Stalled and trading sideways. Watch and see it this can break higher. Tested lower again on Monday and back near the high on Wednesday? Thursday closed at the break out point watch for trade on Friday in the commodity.

UGA¬†– Testing support at $63 … failed as it move to $61.65 on the close. Short play? Look for support and a bounce more than the short side.

5) Global Markets:

Sector Summary:

  • Europe bounced and held the lows – that is the good news. Still looking for some positive momentum to lead the indexes higher.
  • Japan (EWJ) bounced back after some more testing. Looking for a break above $10.20. Got the break higher on Thursday. upside remains in play.
  • Italy (EWI) still in the news and the downside is at support of $12. Bounce held of the break lower on Wednesday. Still interesting short term. The upside bounce may come into play?

Tracking Sectors of Interest:

EFA РBroke support at the $57.62 mark on Monday and traded back above that level on Wednesday. The close above the 50 day moving average was another positive for the global ETF. Still not interested short term.

IEV РAttempting to bounce of the support at $38. Watch as this plays out. Any talk currently is pure speculation, let the trend speak on direction short term.

FXI РTook the short play in FXP and watching the bounce off support near the $37.75 (FXI) on Wednesday. protect the downside against any bounce short term. Thursday bounce continued, but need to move through resistance at $39.25.

6) Real Estate (REITS):

Sector Summary:

  • Homebuilders bounced on news from HD on Tuesday, positive New Home Sales on Tuesday and impressive pending home sales on Wednesday. Watch the upside reversal on XHB.
  • REM – Mortgage REIT held $14.80 support. Nice bounce on Wednesday and Thursday.
  • NLY- Annaly Capital Management finally broke above $15, tested lower on the emotions in the sector, but made a solid push higher today.

Tracking Sectors of Interest:

The pullback test is in play for IYR and $67.25 is support. Moving back towards the high at $68.50.

7) Global Fixed Income:

Sector Summary:

  • The sovereign debt issues had faded, but with Spain in the news again, Italy facing disruptive elections this weekend, and France taxing itself out of existence, too many concerns and the safest play is to avoid the asset class for now.

Watch and play according to your risk tolerance on any position taken. Everyone has different trading styles and you have to find what works for you and your personality. Don’t put yourself in positions you don’t understand or take risk you can’t tolerate. Not every trade results in a profit, but controlling your risk will limit the downside losses.