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Stock Market at a Very Confusing Inflection Point


Is now the moment to hold financials on the strength of coming earnings reports, or fold them? Dance with the devil if you must, but be very careful.


The Joker: Tell me something, my friend. You ever dance with the devil in the pale moonlight?
Bruce Wayne: What?
The Joker: I always ask that of all my prey. I just... like the sound of it.

(Batman, 1989)

The US stock market has clearly started the new year off strong. The S&P 500 (SPX) is up about 3% year to date, while the big banks (as represented by the KBW Bank Index (BKX) are up over 10% as of yesterday's close.

If you bought the basket of financials I mentioned for a trade in my December 29 article -- Despite Reassuring Headlines Out of Europe, Tension May Actually Be Growing -- you are now up about 14% on average in two weeks. Goldman Sachs (GS) is up 10.7%, Citigroup (C) leaped 19.7%, Morgan Stanley (MS) popped 14.8%, Bank of New York (BK) was the laggard at up 9.8%, JPMorgan (JPM) rose 13.1%, and Metlife (MET) soared 16.1%.

So while 2012 has already been a banner year for financials, figuring out when to leave the New Year's party is one of the trickier calls I've seen in a long time. Staying long here sure feels like we're dancing with the devil in the pale moonlight.

While I'm still long the above basket, I am extremely cautious on the near-term outlook. I'm vacillating between selling them and waiting for a pullback, or letting them ride. In order to stay long, I bought some S&P financial sector puts via the SPDR Select Sector Fund - Financials (XLF) to protect the downside for accounts I manage.

That said, an outright sale may be the better course, and it's one I may take shortly. All the charts here are tough. The S&P 500 has resistance at 1305/1308 (up about 1%), and then clear sailing until 1345 (up 4%). The XLF could go to 14.65 and then 15.40 – for gains of about 6% and 11%, respectively. Best case is we consolidate the recent gains with a few days of sideways moves, then move higher. The problem: We have a lot of news to get through in the next few weeks.

Batman: I'm just going to hang around the bar. I don't want to look conspicuous.
(Batman, 1966)

Banks start reporting earnings tomorrow, with JPMorgan the first major to release fourth-quarter numbers. Next week is full of earnings reports. Typically after a big move into earnings, the best trade is to be long into earnings, then sell as the news comes out. But, as far as my sources on the Street can tell, the big boys aren't even in the banks yet, so there's definitely room to move up. Hence, the confusion. I'm hanging around in my longs, but with downside protection in place. I don't want to look conspicuous.

Penguin (organizing his election): Plenty of girls and bands and slogans and lots of hoopla, but remember, no politics. Issues confuse people.
(Batman, 1966)

So what's the confusion about? Why not take note of all the recent good news in the US and stay long? First, the market doesn't like politics – especially these days. Yes, there have been many good things happening for US stocks recently – homebuilders have been strong on the expectation for better housing starts to continue, autos were okay, and industrials and materials stocks have been doing well on the back of expectations for China to ease further and boost their economy, in addition to the bank rally.

But...Europe remains the big wildcard (I know, I'm tired of Europe, too). Europe still has many, many unresolved issues, and if, in the "best"-case scenario, the weaker countries can continue to fund themselves and implement severe austerity programs, their economies will be so weak that the implications for US multinationals doing business there will be severe.

If, in the "worst"-case scenario, Greece (and maybe Spain, Portugal, and Hungary) defaults on its debt or leaves the euro (I know Hungary isn't in the euro, save the comments), then the markets will react very badly short-term (I actually prefer this scenario, as it "solves" the problem quickly). This will give us our opportunity to buy and hold long term, as the prices will likely reflect a dire scenario. In the meantime, dance with the devil if you must, but be very careful. Issues confuse people.

S&P 500 (SPX) Support and Resistance Levels:
Support: 1287/1289, 1281/1284, then 1275/1276 and 1268/1269.
Resistance: 1295/1296, 1305/1308, then 1345/1347.

Editor's Note: For more from Jeffrey Miller, please visit Miller's Market Musings.

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Positions in GS, C, MS, BK, JPM, MET, XLF January Puts.
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