State of the Markets: Where To From Here?

 Up until March 10th, the first quarter of 2009 was one that investors wanted to banish from their memory as quickly as possible. The Dow had fallen another 2,229 points and was down a cool -25.4% with just 16 trading days left in the quarter. Negativity abounded as the talking heads were busy telling us that this was the worst performance for top stocks since the 1930's and how much worse things were likely to get.

It was easy to be downbeat at that time and just about every measure of sentiment was at or near all-time lows. And why not; the stock market was plunging, the housing market was a mess, the new administration was already having trouble communicating with the financial markets (will anyone ever forget the February 10th "announcement" from Tim Geithner?), the economy had stopped on a dime, and the President was telling us at every turn that things were going to get worse.

But Then It Happened

But then, out of the blue, everything changed. Citi's (C) Jamie Dimon and Bank of America's (BAC) Ken Lewis came out on March 10th and announced that things were going well so far in the first quarter. Both men even went so far as to say that their banks had been profitable during the first two months of the year. And Ken Lewis went on to say that Bank of America would likely make money for the full year in 2009.

The response by the stock market was impressive. The Dow soared +5.8% on stellar volume and the argument between our two teams about what the blast meant was on. We took sides immediately and as we wrote on March 11th, "A bounce is more than a bounce when it has a fundamental trigger associated with it."

In the same "Daily State of the Markets" report dated 3/11, we went on to opine, "If banks are actually making money, then the grand plan that Fed Chairman Bernanke has been diligently applying to the economy and the banking system just might be working."

Please accept our apologies for this rehash of history. The point is the market in 2009 has been all about the banks. And since the banks were obviously no longer on the verge of collapsing, we felt that the discounting to the downside had been overdone. After all, with the Fed having set up a "borrow at 0% and lend at 5%" plan for the banks, those that were still in business ought to be able to make money - assuming, of course, that the toxic assets eating away at capital could be dealt with.

Which brings us to the other positives that have been occurring since March 10th. First, the Financial Accounting Standards Board (FASB) announced that they would be making some changes to the mark-to-market rules that had been causing the banks so much trouble in time for the first quarter's earnings reports. Next, the Fed had been busy coming up with all kinds of ways to put money into the banking system. And finally, Mr. Geithner put together a plan to buy up $1 Trillion or so of those nasty assets at the center of this debacle.

So, while we hate to run the risk of angering the Market Gods, we just can't see how the recent developments won't turn out to be the fundamental triggers that turn this whole mess around.

Where To Next?

Since then - and as we expected - we've seen a very nice move to the upside as traders have been busy removing some of the "the world is ending" discounting from the market. The S&P 500 has gained +20.6% over the past 14 trading days and the KBW Banking Index (BKX) has soared +56.6% through Friday's close.

So, now that there is a good chance that we have seen the lows and we have gotten a very nice bounce off the bottom, the question becomes: Where do we go from here?

For starters, let's recognize that this game is still all about the banks. So, if the banks can avoid further difficulties, we'll argue that we're in the midst of a cyclical or "mini bull" that could carry us up +50% or so off the bottom - or at least to somewhere north of 9000 - 9500 on the Dow over the next few months.

In our humble opinion, the key to the extent and duration of this move will be how the P-PIP's (Public-Private Investment Partnerships) perform. Most will agree that Timothy Geithner's plan to join qualified private money managers such as PIMCO and BlackRock with government cash, loans, and loan guarantees in order to create a market for the alphabet soup of securities that caused the credit crisis, is indeed a good idea. However, as always, the proof will be in the pudding.

There are definitely some questions that need to be answered here. Not the least of which is if the banks will actually sell assets to the PPIP's. Remember, some banks have already marked assets to market. So, the pricing coming from the PPIP purchases could easily be higher than the fire-sale prices currently on their books. As such, these banks may want to hold the assets and hope for further gains.

On the other side of the coin, there are also banks that have NOT marked down the prices of their toxic assets far enough. Thus, once a market price is created, these banks may experience more writedowns and will probably need to raise more capital.

The bottom line here is we will need to watch how the PPIP's perform very, very closely.

Trees Don't Grow To The Sky

Unfortunately, we've got some dead air on the calendar between now and when we'll get a whiff of how the PPIP's are doing. For example, applications to manage a PPIP aren't due until April 10th and then it will take some time to get them set up, approved, and running.

So until then, traders will likely return their attention to the macroeconomic picture. And with the exception of this week's better-than-expected news on housing and durable goods, it is safe to say that the US economy isn't likely to turn on a dime. As such, we should probably brace for some more bad news on the economic front in the near future.

We should also recognize that earnings season is right around the corner, which may also provide an opportunity for the bears to run with the ball for a bit. The key here will be to listen to the overall tone of company reports and the guidance for the upcoming quarter/year. Expectations are low at this point, so it will be interesting to see if visibility is improving for the future out there in corporate America.

The bottom line is hot stocks have enjoyed a nice run and there is still the potential for further gains due to window dressing and quarterly asset allocation changes. However, after a stellar run, the bulls have earned a rest. Thus, a pullback would seem likely in the near-term and actually be welcomed by most in the bull camp.

( SDS)
Date Purchased: None Yet
Price: Here or Over $72.83
Buy Strategy: Yes, we featured this play last week. But since we didn't pull the trigger on the trade and nothing has changed in terms of the reason why we'd be looking to "go the other way" for a trade, we'll feature the SDS again. We continue to be on the lookout for a pullback in the near-term and would play the SDS (an inverse ETF leveraged 2 to 1 to the movements of the S&P 500) once the move to the downside gets going.
Active Trader Stop: $68.89

PG (Procter & Gamble Co.)
Company Profile
Our Success Trading Group members closed a winning trade on Procter & Gamble (Ticker: PG) this week when we traded in and out of PG the same day. We have several top stocks on our radar and are looking forward to trading next week.

MYGN (Myriad Genetics--$43.58; -0.06; optionable): Diagnostic substances
Company Profile
After Hours: $43.80
EARNINGS: 02/03/2009
STATUS: Breakout test. MYGN surged higher to start the last week of March and then split. After splitting it has come back to test the move, holding over the 18 day EMA (42.79) and showing a nice tight doji Friday. Testing the breakout from something of a short 6 week cup that used the 50 day EMA (40.53) as support. Looking for MYGN to complete its test this week and give us a buy point as it breaks back to the upside.
Volume: 1.2M Avg Volume: 1.823M
BUY POINT: $44.32 Volume=2.5M Target=$50.94 Stop=$42.66
POSITION: GSQ HV - Aug. $42.50c (62 delta) &/or Stock

C (Citigroup, Inc.)
Company Profile
$10 Trader is looking to add to the recent successes and Citigroup (C) definitely looks like a candidate. The stock has moved up quite well from the March doldrum. It is currently trading just below $3 and it looks like it could make a move up of $1.20 or so before hitting resistance around the $4.00 mark.

AAPL (Apple, Inc.)
Company Profile
After trading in a nice channel for almost five months and giving us upside and downside plays in its $20 range, AAPL started to show a character change mid-March. As it approached the high in the range we were readying for a downside play again, but we were also aware that AAPL had made 4 prior cycles in the pattern and after that many rolls up and down a pattern tends to break down. Thus we were also watching the upside to see if AAPL made a breakout.

When it approached the top of the range at $103 it paused and moved laterally for three days. That was the first sign things were different. In prior visits AAPL touched the top of the pattern and then turned and ran like a scalded dog. This time it paused, and on the fourth day it broke through the top of the range. Now we could have bought in on that move, but when a range is broken, particularly a well established range such as this one, a stock typically comes back to test the move, i.e. after the initial burst it fades back to touch the top of the range. AAPL did just that, working laterally a couple of days, moving to $110 on this high. It then faded back, falling to the 10 day EMA on 3-30 (Monday), showing a doji on the candlestick chart. When testing a breakout, a strong stock will often use the 10 day EMA as support. In this instance the 10 day was at $103.90, just over the top of the trading range so it was perfect for a test of the breakout.

We put AAPL on the report that night. The next session AAPL started back up on a bit higher volume. We bought into the position with some stock positions at $106.54 and some May $105 strike call options at $8.50, looking to play the options on that first strong run higher following the breakout test. The 200 day SMA was up at $120, and we were looking to play a move up to that as our initial target.

AAPL closed off the session high Tuesday, but it jumped $3.57 to start the new quarter. It added $4.02 the next session, clearing the key October/November peaks. That opened the door for a run toward the 200 day SMA. On Friday AAPL was at it again, gapping higher and running to $115.99 on the high. It was dilemma time: a strong three day run heading into the weekend but not quite to the 200 day SMA that had moved down to $118.78. We split the difference. Sold a third of the stock at $115 for a 7.9% gain and sold half the options at $14.45, banking $5.95 per option or 70%. Not a bad take for less than four days in the play.

Playing established trends or patterns is one of the best ways to make money in any market. Being able to recognize WHEN A CHANGE is coming, however, is the key to KEEPING what you have made on a trend and then making money on the new move. If we had blindly shorted or bought puts on AAPL when it touched the top of its range again we would have lost money. Instead we recognized where it was in its life cycle and were ready to play it EITHER WAY it moved. As it is we caught what looks to be the start of a new phase in AAPL after a 6 month base.

HD (HomeDepot, Inc.)
Company Profile
Home Depot is currently dealing with resistance near the $25 mark. A break above that level could portend a higher move. I'm considering some long term in the money calls on HD if it can poke above $25.