The well-worn statement of “don’t fight the tape” couldn’t be more timely this week, with the SP 500 clearing the technical and psychological hurdle of 1,900 yesterday, putting shorts on the ropes and backing the bears into a corner.
What happened to the “sell in May and go away” crowd? If you tune in to CNBC, most of those talking heads have been, well, talking down the market, taking their cue from some leading hedge-fund managers that waved the caution flag earlier this month.
The dichotomy that has the “experts” miffed is: How can the bond market and the stock market both be right? One of them has to give…right? Well, not necessarily.
The economy is likely to show 3% GDP growth annualized for the month of May with little threat of core inflation that does not include food and energy. Add those two components, and the annual inflation rate probably approaches the Fed’s stated objective of 2%. That is still very manageable and no cause to dump bonds, especially when the 10-year U.S. Treasuries pay a higher rate than that of comparable sovereigns like Germany, Japan and the United Kingdom.
People call this market the most unloved rally they can remember. Most of the high-beta sectors that led in 2013 got rinsed out in the first four months of the year in a massive rotational shift into blue-chip dividend-paying stocks. Then, against all odds, the 10-year Treasury rallied from 3% to today’s rate of 2.45% in the face of the Fed tapering $30 billion per month of bond purchases to date.
All the while, bearish calls that the housing market recovery was cooked were rendered off the reservation this past week when new home sales, existing home sales and the Case-Shiller 20-City Index, each showing price appreciation, all came in above forecasts. Other market risks of a hard landing in China, Japan and Europe have also been greatly diminished by improving data points in all three of these key economies. In addition, Ukraine’s election went off without a hitch, Russian troops are standing down and the country voted in a pro-business billionaire.
In essence, what has happened in the past couple of weeks is that a number of overhanging negative influences have been removed, opening the way for risk-on capital to return to the equity markets, even as we enter what is historically considered a lackluster time of year for trading and volatility. What traders now face is having to go into the summer months with what may be a fresh breakout in the making for the major averages. Sounds like there will be a lot of money managers forced to stay indoors and take a “working vacation” in the Hamptons in the weeks ahead.
However, just because the SP 500 cleared 1,900 does not qualify it yet as a clean breakout. Ideally, we want to see the market trade at or above this level for a few days for confirmation that investors are not falling prey to a false breakout. This is the third attempt to trade above 1,900 and was done so with the support of the Dow, Nasdaq and — more importantly — the Russell 2000, which was able to retake its 200-day moving average.
While we wait for confirmation, bullish positions with built-in hedging are perfect for traders looking to capture a quick gain. I accomplish this through short-term covered calls, and I’ve got a new one for you today to play both the emerging strength we’re seeing in the SP 500. A short-term covered call is the best way to play it, and one that looks good to me technically is Blackstone Group (BX), as the stock is finding good support at its 200-day moving average.
For every 100 shares BX you own or purchase at market, sell to open one BX June $32 Calls at $0.30 or more, good till canceled.
As financials regroup, BX shares should clear the $32 strike by June expiration. So, if you pick up shares around $31 and simultaneously sell to open the BX June $32 Calls at current levels, if BX shares are called away from you the Monday after June expiration as I expect, you stand to make an easy 4.35% in a few weeks’ time.
(Your exit price is the $32 strike plus the $0.35 you collect for selling the calls, so $32.35 – $31 buy price for the shares will give you a 4.35% percent return.)
The new tug of war at the 1,900 level for the SP 500 will be fought hard into the weekend and then even harder into the month of June. That’s why I like short-term covered calls that allow you to profit first at the start by selling the calls, and then again when the underlying shares appreciate and then are called away from you.
For now, my bias is to the bullish side of the fight, because trader sentiment is not even close to the bubbly enthusiasm typically associated with a market top. It sets up a backdrop for the market to “climb the wall of worry,” as it would be, and I’m just fine watching all the bears gnash their teeth on the way up.
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