The question now – stay out?  The answer, in my opinion, is yes.

Of course, we could get a bounce.  In fact, we are due for a bounce.  But the macroeconomic picture will not change until there is a resolution in Greece.  And in fact, the market will assume, without concrete news to the contrary, that the worst case is most likely when Greek elections arrive in mid-June.  That means, the market is likely to sell off before the elections, just in case the worst case does happen.

I find it odd, and even disturbing, that there are many on CNBC saying buy, that the market is oversold, that stocks are cheap.  Yes the market is oversold.  Yes stocks are cheap.  And yes, the drop in May stocks since May 1 is already petrifying.  All that is true, and we might get a bounce, but I don’t see any reason why someone would buy now and hold onto their stock.  And, there’s also every reason for every rally to be sold.

To me, all that adds up to this: stay out of the market.

Confusing?  Yes.  And perhaps it’s worth considering that we are over thinking the jobs report.  If we step back a bit, the bulls are calling for a rally in the range of 1450 – 1470.  The bears say we’re on the verge of a correction, in the 8-10% range.

I think it’s very hard to say which way the market will go.  But I do think that we’re limited on the upside – perhaps at most, 3-4% if the bulls are right.  It’s possible, but to be honest, I’m not sure what would cause someone to buy.  There’s not a whole lot of catalysts left – Europe is weakening everyday; the earnings story is nearly done, so I don’t know where the upside surprise would come from; China isn’t clearly in trouble but it’s not fueling growth either.

On the downside, I don’t see a reason for an immediate collapse, but we have several scenarios over the next several months that could bring the market down.  Fundamentally, slowing Europe, and perhaps a slowing US, could mean slow growth through the summer.  Q2 expectations are low – only about 2% growth, so we could beat that but it’s hardly a reason to take lots of risk.  Also, many companies have given cautious outlooks.  Then there’s Europe.  We have elections in France (with the second run-off election as soon as this weekend) and yields in Spain that could hit that alarming 7%, time-to-fear contagion level.  The ECB could step in and buy bonds, which will help for a little while, but we could easily wake up one day later this summer and find markets spiraling down.  Lastly, I would say technically, markets are due for a sell-off in the near future.  Many stocks are at recent highs; others are already fading.  Overall, rallies aren’t continuing – there’s a rally one day, a sell off the next.  It seems more like investors are selling, and new highs are actually caused by short-sellers who have to cover.

Last time, I said, sell in April.  We’ve rallied a bit since then, but I continue to think that the risk-reward is not in favor of the bulls.  We could rally, but only a few percent at most, whereas downside sometime over the next several months has a relatively high probability.  So, I stay in the same camp – sell rallies.  As for the jobs report, whichever way the market reacts, the fundamental picture is not likely to change.

• Spanish yields are rising.  If this continues, we will have the same whiplash in markets that we had when Greek and Italian bonds hit high yields.  Perhaps even worse, because Spain is a big economy.
• French President Nicholas Sarkozy is likely to lose to Hollande on May 6th.  If this comes to be, then this will break up the Sarkozy-Merkel partnership that has led Europe so far.
• Much of Europe is in or nearly in recession.
• Political instability in the Netherlands could take months to resolve.
• Concerns that Italy’s austerity plans are insufficient are rising.
• There are no clear indications that any policy responses are in the works.

If we want a technical justification for wanting to stay away from the stock market, take a look at the following chart:

If you draw the trend line from late November, that line was broken earlier this month.  If you go back further and draw the trend line from early October, that trend line broke this Monday.  There’s more technical evidence we could pull out, but here’s the thing to think about: usually when things like this happen, the market needs a reason to overcome the break below these technical levels.  The European concerns, combined with a lack of reasons to buy, will likely make the summer tough.

By the way, China will likely stimulate at some point, but probably not right away.  So there’s no real catalyst there.

And how much should an investor trim?  A lot depends on your current holdings, how exposed they are to sectors that will be affected and your risk tolerance.  If it turns out to be a tough summer, the TLT, the 20-year bond fund, could be a good defensive bet (I am long TLT), and if you want to be aggressive, you can go for the inverse (or short) ETFs.

The last several years have been all about the macro economy.  We had a few months where we could forget, but we will have macro concerns for years to come.  So far, there’s no reason to think this summer will be any different.

How serious is this breach of the 1370 level?  The next levels of support are 1357, the low yesterday and today, and 1340, the support levels in February and March.

The market is trying to decide which way to go.  I think much depends on earnings.  Expectations are that earnings will be weak, especially because of tough year-over-year comparisons.  If earnings over the next couple weeks disappoint, the market will likely fade away.  If we get some better than expected results, we could get some support.  The bull hope is that earnings are good enough to give the market an upward push.  Financials, including JP Morgan and Wells Fargo, report early, starting this Friday.  As a sector, there is hope that they could put in respectable results, especially given their success in the stress tests, a better trading environment, the resolution of the mortgage lawsuits by the states, bottoming real estate prices and some loan growth.  Still, other sectors, especially energy, commodities and industrials remain questionable.

Bottom line, we have a decent risk of downside vs. a moderate probability of further upside.  We could get another push upward, but if we did, the risk reward changes dramatically if we just go up a little more.  We’ll see more resistance around the 1390-1400 range and would need strong catalysts to break past the recent high of 1422.  If we get to the 1400 range, we get high risk of downside versus very limited reward of hitting the 1400-1420 level.  With this calculation in mind, those that bought when the market was above 1400 would have a strong incentive to sell as the market approaches that level.

If you haven’t had the opportunity to position your portfolio defensively, I’d consider the following:

(1) Sell rallies (unless the economic picture changes), build some cash.

(2) When the market is rallying, but puts on the market in general, or to hedge specific long positions.  Also, there are short or ultrashort ETFs that can be purchased.

(3) Reduce the beta of the portfolio.  For those that aren’t familiar, beta refers to how much a stock moves relative to the market.  A stock with a beta higher than 1 moves more than the market, a stock with a beta lower than 1 moves less than the market.  You would not be surprised to find that Bank of America (BAC) has a very high beta, while something like Johnson and Johnson (JNJ) has a very low beta.  The basic idea is, you want to reduce your exposure to high beta stocks when the market declines, because high beta stocks will cause your portfolio to drop more than the market does.

(4) Consider defensive securities, such as the TLT, the 20-year Treasury bond fund, when the market is rallying.  If the market falls, money will move into defensive securities such as bonds.

Personally, if we see the market having trouble moving upward, I would be inclined to wait before buying anything.  Let the dust settle, if there is a more serious correction, let it play out before buying.  We’ve had a drop from 1422 to 1368, which is already 3.8%.  If we have trouble moving upward, we are likely in for a 5-10% correction as opposed to a 3-5% correction.

As I wrote in my last post, I expect a slow summer.  If this scenario plays out, I’d look for defensive stocks, includings stocks with (1) dividends and (2) product cycles in front of them.  Examples would be Intel (INTC), which is selling lots of servers in this data driven world, and Microsoft (MSFT), which has the next verisons of Windows and Office coming out later this year.  Altria (MO) and Phillip Morris International (PM) are also consistent performers with hefty dividends in riskier environments.

I or my clients am have positions in SPY, BAC, JNJ, INTC, MSFT, MO and PM.

In short, the market was trying to decide, and data, Fed speeches, company announcements all pushed markets one way or another at the drop of a hat.  Of course, this flip-flopping eventually had to end, and it did, with last Friday’s disappointing jobs report.  The government reported a decidedly disappointing 120,000 increase in non-farm payrolls; the markets had expected about 200,000.  Not a small miss and the implications were clear.  Growth is sluggish; not robust by any means.  QE3 remains a possibility rather than an unlikely outcome.  Markets promptly sold off, bringing us to 1382 as of Monday evening, April 9, 2012, about 2.8% below our recent high on the S&P.

To be accurate, it wasn’t the single jobs event that turned the market’s opinion.  After one of the best quarters in recent history, markets were ready for a pullback.  Earnings season also wasn’t expected to be strong, especially given a strong Q1 in 2011 that would make year-over-year (YOY) comparisons tough to exceed.  And while we had forgotten the world’s problems in the first quarter, Europe and China have been waiting to remind us that they will not be forgotten.  So really, as the historians would say, the jobs number was merely the near-term catalyst that pointed the market in the direction of longer-term worries.

Unfortunately, this doesn’t leave us much to look forward to for the summer.  For one thing, it is likely we have passed the height of optimism, which was at the end of March.  For continued upward movement (in other words, for the world to be better than it was in the first quarter), Europe would have to be a non-issue; China would be growing above the lowered expectations of 7.5%, and the US would have to be on its way to a recovery.

None of these things are likely to be a certainty this coming summer.  So significant upside during the summer is unlikely.  Instead we have two more likely possibilities: the world plods along, but is stable; or Europe, China or Iran flares up, dramatically increasing risk around the world.  This leaves us, in the markets, with a choppy sideways market or a stomach churning downward trip that has only become all too familiar in the last several years.  For now, we are in no immediate danger of going over any cliffs, so some sideways choppiness, or choppiness with a downward tilt, is likely in the coming weeks.

A somewhat more detailed review of sectors would confirm this initial outlook.  In general, tech is likely to be soft through the summer.  Europe will not be a major buyer of tech goods, and China might do a little more than it has in recent months, but that’s only because the Chinese government has been slowing down the economy for the last several months.  Tech also has seasonal winds going against it.  The summer tends to be slow for tech, because companies usually buy late in the year as 2013 plans crystallize.  If you look at energy, commodities and industrials, we have similar concerns: who will be buying over the summer?  Companies and countries are likely to be cautious and customers have no reason to spend a lot  Maybe a little, but not a lot.  Financials, or at least US financials, are in decent shape, but are likely to show limited growth.  Loan growth is increasing in the US, and real estate may be close to a bottom, but neither of these trends can be said to be explosive.  The trends are positive, but more likely slow and steady than anything else.  And given the jobs report, longer term interest rates may rise a bit, but not a lot.  Since banks benefit most when there is a big difference between longer-term and shorter-term rates, the story is likely to be the same here – positive, but slow and steady.  Taken together, these sectors represent a large chunk of the market.  Without forward movement in these sectors, the market as whole will have problems as well.

So this year, we could well have a case for sell in May and go away.  Next time, a few more thoughts on what to do during the summer.

The key event: the Fed minutes indicates that there really isn’t that much support for Quantitative Easing 3, aka QE3.  Now many argued this, but there were plenty of others on the other side.  Today, the non-QE3 side won.

No QE3 implies that the economy is in good enough shape to handle things without support from the Fed.  That’s good, bullish news.  But one thing to keep in mind: all this means is that for now, for today, perhaps even for a few months, the markets will support this point of view.  Now there are plenty of skeptics, there are plenty who believe that Europe will come back to haunt us.  And that may very well happen.  But for now, the Fed is unwilling to push QE3, and markets will behave as if this is reality.  We, as investors, must remember that what we believe today and reality in two weeks or two months could be a very different thing.

The other thing to keep in mind is that we closed today on the S&P at 1413.38.  So far, we are holding the 1400 level on the S&P.  This is initial support, and next support is 1370, as discussed in previous blogs.  If we hold 1370-1400, the target 1425 – 1440 range remains a possibility.  If not, we have the long awaited correction.

So here’s the many implications of today’s minutes, and the idea that the US is in good enough shape that QE3 will not be necessary.  Again, this all assumes that we hold current levels:

(1) The Fed will soon end operation twist.  Officially, this will happen on June 30th.  If the market is in good shape, this means that long term interest rates are likely to rise.

(2) The first derivative effect is that bond prices will fall.  This means that any instrument tied to low term interest rates, will be sold.  No surprise, the TLT, the 20 year bond fund, fell today, and has fallen over the last couple weeks.

(3) Banks, who borrow and low short term interest rates and lend at (hopefully) higher interest rates, will benefit.  I continue to favor the financials in this environment.

(4) The dollar will rise.  That’s because the US is in good shape, and because higher interest rates will draw money from abroad.

(5) Gold will fall.  Higher interest rates, a better economy, makes gold a less interesting investment.

(6) US exporters will suffer.  With a higher dollar, US exporters will have a harder time selling overseas.  So those that depend on overseas sales will have lower Q2 earnings.

(7) Usually, a higher dollar is bad for commodities, because commodities are traded in dollars.  With the higher dollar, commodities become more expensive.  On this one, I would look for confirmation of this effect by watching the price of commodities.  That’s because, there could be other factors involved.  For example, the higher dollar would usually be bad for oil, but continued fears about Iran could keep oil high.  So rather than trade on this idea, look to see how markets for commodities react first.

(8) Depending on how high longer term rates rise, real estate could be impacted.  A small rise in longer term rates may not be a problem; a bigger rise could choke off the recovery in real estate.

We tend to look at the big indices – Dow Jones, S&P – first, but interest rates has ripple effects across the economy.

Finally, keep in mind that if problems in Europe or China worsen, some of these trends would reverse.  So for example, problems in Europe or China would make investors rush back into bonds, driving prices back up and yields down.

Yep, I lot to think about.

To be fair, all sorts of scenarios are possible now, I don’t think there is a definitive case of any particular outcome.  Next week will be the end of the quarter, and so we are likely to have some window dressing.  That could take us up to 1425 – 1440.  After that, April brings French elections, possible Greek elections, earnings and possible Spanish worries, which are just beginning to surface now.  There’s not much of a case for further upside, plus many stocks and indices do look overextended, or at the very least toppy.

We could also fail to break above the recent high of 1414.  That would be a very negative scenario, because that would essentially be a double top, a classic bearish configuration.

And there’s the final possibility of breaking below 1370.  I don’t see a particularly strong case for this at the moment.  Despite the concerns about a slowdown in Europe and in China, the market is not yet alarmed.  The VIX remains relatively low, under 15, and a pullback is perfectly reasonable.

So at the moment, my working hypothesis is that we will get a little bit more out of this rally.  Still, we shouldn’t be fooled.  Underneath it all, the market is having an increasingly hard time pushing to higher levels.  Questions about growth in Europe has raised questions about critical sectors, including industrials, materials and energy.  There’s also rotation out of profitable sectors into weaker ones or more defensive ones.  Basically, there’s plenty of activity, but the forward movement is less definitive – what I call “churn” in the market.

We could be in a topping process.  We often like to point to a day, a level on the S&P, or a number as the specific “top”.  But in reality, the top is a process that takes time.  Often, there are many attempts to move forward, but less and less progress is made.  As we move into April, we should be particular aware of this pattern.

Before diving into the rationale, just a quick note on the target.  I had previously called for 1425, but to be fair, 1425 is the May 2009 closing high, 1440 is the May 2009 intraday high.  You will hear both numbers from various technicians, so I am citing the range.

So here are the indicators that are making the bulls happy:

(1) after a 24 point jump in the S&P, a nearly irrelevant 1.67 point drop is extremely bullish.

(2) the biggest indicator was the drop in bond prices.  The TLT, the 20+ Treasury bond fund, broke it’s previous resistance level of 115 and has even fallen below it’s 200 day average at 111.52.  It closed at 111.04 today.

(3) gold is also dropping – fast.  The GLD broke down below the 100 day moving average, and has plunged past the 200 day moving average.  While the long-term uptrend remains intact, the GLD was about 173 a couple weeks ago.  Today, it closed at 159.57.  This means that there is less fear in the market.  In the long term, the problems remain, but for now, the markets are not particularly worried.

(4) the VIX remains at lows it has not seen since last summer, before the August breakdown.

Barring a worldwide event (like Israel striking Iran), the bulls have control of the ball.

I am long TLT, GLD and SPY puts.

I don’t think the longer term picture changes.  We have French elections and possible Greek elections in April, as well as earnings beginning mid-April.  Still, given these recent changes, we now have to consider more seriously the possibility that we rally to 1425 or so on the S&P, especially after the stress tests this week.  Afterwards, we may try to hold on, but we could easily fade into April, and especially mid-April.

While I’ve trimmed industrials, I bought financials earlier this week with the stress tests on Thursday as the catalyst for further upside.  I didn’t know whether we would get sell the news, but with the market as a whole moving up, if we hold above 1370 then we are likely to continue moving up after the stress tests on Thursday.  I”m reluctant to buy other stocks that have had a fairly large run up, but will continue and may even add to financials.  We have the Fed outlining their position today, so their take, and the market reaction, will inform my outlook.

If we get a deal on Greece, we could have a bit of a rally tomorrow.  If the employment number is decent, that rally could extend into Friday, or perhaps even next week.  However, the recent high was about 1375 on the S&P, and today, we closed at 1352.63.  I do not think a rally will push us through 1375, and if it does not, then this is a time to sell or trim.

I am long S&P calls right now, but I am looking to sell them in the next day or two, and even to go short in select stocks.  Also, I will be considering buying the TLT, especially around $116 (this is a bearish call, because the TLT is the 20-year bond fund, and going into bonds means heading for safety); as well as the TWM, which is short the Russell 2000 as a hedge.

As I mentioned in my last post, we have a breakdown in the transports and in the small caps.  Materials are also faltering.  These all reflect doubts about global growth, so even with a deal in Greece, and a good employment report, Europe and China will remain in slow down mode.  Unless we get news to the contrary, these sectors will be a drag on the markets in the near term.