This week could prove to be interesting for investors as we have the Fed on tap, the earnings season kickoff and we end with the non-farm-payrolls on Friday. What more can you ask for? This is the kind of week where you should pre-order your champagne and/or Valium.
Having posted a phenomenal September, with the S&P 500 closing 8.4% higher, it seems like the main focus has turned to protecting profits and climbing with caution. Traders are keeping their eyes out for any indication of a top and this can sometimes be misleading.
If you are looking for a top, then the way you interpret data will be biased toward your point of view. One example would be the large put option volume on the SPDR S&P 500 ETF (NYSE:SPY), seen by some as being an indication that the markets will tank.
While I can see the logic behind this, the context of the situation is extremely important. The context being an extremely strong month where key resistance levels were breached and earnings season around the corner. This put option buying activity could be tied to long positions in the markets, which would help hedge against any sudden drops while locking in profits.
With a hedge in place, there is little reason funds would not continue, or even ramp up their buying. While I don’t think it is likely that institutions will accumulate stocks in large volumes during earnings season, there certainly is a considerable amount of volatility and this supports my hedging thesis.
Investors Look to Earnings
As far as earnings are concerned, seeing some positive reports and optimistic forecasts will give funds the conviction to continue buying. Needless to say, a few bad reports in quick succession can lead to a large drop in the overall markets, but key support would need to be decisively broken to shake off the bulls.
Although I’m not a fan of the economic picture, the timing of economics is very different from the financial markets. Despite an increasingly dismal economic backdrop, investors still managed to pile into equities in September. The mainstream media is calling for a massive bull run and sentiment is reaching crash-like levels.
In addition to this, the Federal Reserve seems awfully worried about something and have been rather tight-lipped about it. Although they only provide very ambiguous comments on the general state of the economy, only providing enough negative detail to support their inflationary agenda, their actions speak for themselves. The latest wave of quantitative easing has caused me to believe more in the double-dip recession thesis. Time will tell what is in store for the world economy.
The way I see it, the markets are always right in the short-term. Right does not mean that price has factored in every single possible variable. It means that if the market goes against you, then you are wrong, not the other way around.
The long-term economic trends will always win in the end. There is a surprising disconnect between market price action and the state of the economy from a timing perspective. It may take months or even years before markets align with the economic reality. That is why my short and medium-term trading theories are mostly based on technical analysis. Keep it simple and trade what you see, not what you think.
So with that said, I will be watching out for the Key Levels in the Markets as well as how investors react to this news-filled week.