Weekly Binary Options Forecast 8/12-19/2013: Stocks Lower on Limited Fundamental Drivers

Stocks Lower on Limited Fundamental Drivers

US macro data generally positive, but this is only adding to increased tapering possibilities.  Elevated stock levels likely to lead to profit-taking in global equities.  Divergence between fundamental and technical pictures on the US Dollar, creating a buying opportunity in the currency against the Yen.

Despite a general slowdown in volatility, some interesting activity was seen in stocks last week, as US equities markets posted their worst 5-session performance since June.  From a valuation perspective, stocks made these moves after the S&P 500 traded at 15.3 times earnings (the highest levels in over three years), which was a strong increase from the 13.1 valuation that was seen in the index at the beginning of this year.  The declines are being propelled in large part by the consistent improvements in US economic data, which seems like a contradiction.  But the reality is that the stronger data is leading to enhanced speculation the US Federal Reserve will have additional leeway to start cutting back on its stimulus programs, which will take one of the legs out from under the world’s largest economy. 

On the whole, earnings reports in developed markets have been strong.  Roughly 75% of the reporting companies have posted earnings that were better than market expectations, which does offer some justification for stock values maintaining their relatively elevated levels.  This is also in stark contrast with the general trends seen in emerging markets, as nearly 60% of the companies listed in the MSCI emerging markets index have released earnings that disappointed analyst expectations.  Given these trends, it is more than likely we should see relative outperformance in stock indices in developed markets, relative to their emerging market counterparts (areas like China, Russia, and Brazil). 

The Week Ahead    

 In the week ahead, there is not much to get excited about in terms of economic data, as the biggest releases will be US Retail Sales, and GDP figures out of Germany and Japan.  It is unlikely that any of this information will drive many new positions so the main question will be how markets are likely to respond to suggestions that quantitative easing stimulus will start to be phased out.  For these reasons, it will be important to watch for any commentary from voting members of the US central bank.

Other than that, traders should prepare for position squaring, as we are seeing some big (and largely unjustified) moves in the US Dollar that are likely to start reversing.  This should lead to successful upside breakout strategies in the US currency against most of its counterparts.

My Trading Ideas: 

1. Recent weakness in the US Dollar is unlikely to continue, given the consistent strength we are seeing in economic data and the increased likelihood the Fed will start to cut back on stimulus.  Going forward, I will be looking to play off of the latest bear moves in the USD/JPY, and will consider adding positions in the Australian Dollar as well. This week, look to buy weekly CALL options in USD/JPY at the week’s open on Monday, which should come in near the 96.10 area.

2. For stock trades, I will be looking to capitalize on the generalized weakness that will probably mark equities next week.  Given this bearish expectation (based on profit taking, additional tapering worries), it makes sense to get stock bearish in the S&P 500 right at the open. From a technical perspective, we will see a triggered head-and-shoulders formation in the S&P on any break below 1680. Buy weekly PUT options in SPY on Monday’s open, which should be just under 1690.

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