Although many people have underestimated the power of this rally, we may be seeing some more concrete symptoms of a market that may be getting ready to turn, or at least begin to trade in a more consolidative manner.
The next week will be very telling as to the near-term direction of the market, as event risk this week ahead of non-farm payrolls has thus far prevented any real market direction.
We are again seeing some weakness in the data. After what seemed like a major league hitting streak for the economic data, the data recently have been showing cracks.
The housing and durable goods orders from last week are two examples. In addition to the data, investors are becoming increasingly anxious over how things will fare once the government programs are wound down. Of particular concern is how housing will do once the first-time buyer's credit is gone. Assuming this trend continues, one must wonder how much gas the buyers have left.
Secondly, the market has not been able to breach the recent highs. The December
futures hit a high on Sept. 17, but closed off the highs. On Sept. 23, the market probed above the highs of the 17th but could not close above that level.
What is this telling us? It's likely an indication that the "smart money" is now selling out long positions to the "crowd." Remember, the "smart money" never wants you or me to know its intentions, so this will be a process of that money liquidating longs; it will not be accomplished in a day.
Monday's rally is another good indication of what I believe is occurring. Although the market staged an impressive rally, it was on extremely light volume. Clearly the buying interest is beginning to dry up at these levels and/or the sellers have become numerous enough to hold them at bay. Kind of like a good old-fashioned tug-of-war. The big question is who will win.
Finally, investors must be concerned with how third-quarte earnings. This time around cost-cutting and layoffs will not be enough. Investors are going to want to see some top-line growth. Beating estimates when the bar has been set so low will be insufficient to keep this rally going.
I am watching the 1060 level on the S&P futures very closely. A break above could indicate prices extending into the mid 1080s. The big number I am watching on the downside is 1036. This represents a trendline and if broken could lead to accelerated selling, as the market will be lined with sell stops on the downside.
The option premiums on the call side are just not there right now and do not justify the risk taken. Better to be patient and see what develops. I do like the idea of buying puts at this level, however. I am looking at the November 1000 puts.
As of this writing, they are trading for approximately 16.5 points or $4,125. They have 51 days until expiration, which gives a fair amount of time for a downside scenario to develop. In addition to the market falling, these positions can also profit from an increase in volatility.
I do not recommend, however, holding these positions any longer than three or four weeks, as the time decay will be greatly accelerated, decreasing the odds of a profitable trade. If I am dead wrong in my analysis, or the market simply trades sideways over the next couple of weeks, I will exit the poosition, take the lump and preserve capital.
Risk disclosure: Past performance is not indicative of future results. The risk of loss in trading futures and options is substantial and such investing is not suitable for all investors. An investor could lose more than the initial investment.
Matt Zeman is a principal with Lasalle Futures Group and chief market strategist for Time Means Money.Com.