Thougts for the week ahead - 04/13/08

I believe the next few days will be key in determining whether this market will remain range bound between 800-850 or move up into a higher trading range, perhaps taking a run at 875 or even 900 on the SPX. I don't really know any better than anyone else, but my analysis shows that the the odds are slightly in favor of a move higher, although some profit taking and technically overbought market will likely create some downside volatility. If we can go sideways and finish next week flat to slightly down, I will consider it a win for the market and will likely increase my long exposure by 10%-15%.

Here's my thought process and conclusions.

Positives:

1) We had a very strong start to the earnings season with Alcoa, which kicked it off, reporting weak, but better than feared results. This was followed by Wells Fargo, that positively pre-announced very, very strong profits, much better than the street expected. We also witnessed a number of other results that came ahead of the analysts' expectations, although most were pretty dismal, looking at YoY comparisons.
2) We did have a very strong, unexpectedly strong end of the week move, led a super strong showing from one of the weakest groups - Financials.
3) Closing at the high of the day is always a positive sign, generally leading to continuation of the trend. Technically we closed just above 850, which is a major resistance level for SPX.
4) The short interest is still very high, with March short interest hitting 4.3%, one of the highest readings since September 2008. It will need to work through the system.
5) Earnings estimates for Q1 are very sensible and seem achievable, as analysts already took a hacksaw to expectations. Ditto with ratings. The number of downgrades over the past few months has created an environment where the estimates and ratings already reflect a very very difficult economic environment.
6) Some of the industries are beginning to see stabilization, or in some cases, dare I say, improvement, as we are seeing some early signs of lending, combined with inventory replenishment ( inventories in some industries are running very low)
7) After almost zero activity for the last 6 moths, M&A chatter is picking up. There were some transactions announced over the past few weeks, and daily rumors are beginning to intensify. If we start seeing actual announcements this would add fuel to this rally, but in any case should keep the shorts on their toes.
8) Retail sales reported on Thursday were pretty bad, but again, already reflected in very very negative outlook for retail and consumer spending. Many of these retailers, to my earlier point, rallied on negative comps ( WMT being an exception).
9) We are not really reacting as badly to negative news, a clear sign of changing sentiment.
10) The mutual fund flows last week were a cool $12b, 4x what they were a week before. By some estimates, there is still over $3.5T of cash on the sidelines, that exited the market last year.

Negatives and Unknowables:

1) We are clearly overbought based on my short term stochastic indicators, and have overcome to very strong resistance levels, a trendline at 850 and .62 Fib Lvl at 860.
2) This week will bring more earnings and associated volatility with following key SP components reporting:

Goldman Sachs, Intel and Johnson and Johnson report earnings Tuesday, while Abbott Labs and Peabody Energy report Wednesday. On Thursday, J.P. Morgan, Google, Baxter, Harley-Davidson, Nokia, Parker Hannifin, Biogen Idec and Southwest Air report. Citigroup, General Electric and Mattel report Friday.

3) More economic data will be out next week, after a pretty slow economic news week, including Fed's Beige book, PPI, CPI, etc. We will see how it shakes out.

Strategy for next week:

I am currently net long and will remain so, unless we decisively break below 790. I may sell a few non key positions, but will likely just ride out the volatility since I am beginning to be more concerned that a real rally is taking hold. If we do pullback to low 800's and stall, holding all the major support levels in tact, I will be aggressively adding to energy commodities, select china and tech. I will be posting my trades on www.marketguru.com and will review some of them in detail next week.