Daily Commentary: October 26, 2021

Jeremy Engelbrecht1Option Commentary

Big Tech Earnings On Deck – Reaction Will Determine Market Direction

Posted by Pete Stolcers on October 26

The S&P 500 is within striking distance of the all-time high and it has traveled more than 200 points in just over a week. Earnings season is kicking into high gear this week as mega cap tech stocks prepare to release results.

FB posted results after the close and even though they missed on the revenues they beat on profits. This has been the most beaten down of the big 5 tech names. It bounced off of the 200-day MA and the results were better than feared.

MSFT and GOOG will post earnings after the close today. AAPL and AMZN will post earnings after the close Thursday. The reaction to these announcements will set the tone for the market and these 5 companies comprise almost 25% of the market cap for the S&P 500. This will be the busiest week of earnings. The misses from SNAP, INTC and FB were completely ignored and that is a red flag.

The momentum has been incredibly strong with gaps higher and stacked green candles closing on the high. The volume is light and that is a sign that there is a seller’s boycott (no one wants to sell). This morning the S&P 500 is set for another gap up (20 points).

These are the market forces in play and the bullish forces are winning.

Reasons to be bullish:

1.Interest rates are not keeping pace with inflation (negative real returns) so investors see stocks as an attractive investment alternative.
2.Corporate buy backs are steady.
3.The long term trend is up and the market formed a base at the 100-day MA.
4.We are heading into a seasonally strong period.

Reasons to be bearish:

1.Stock valuations have not been this high since the 2000 tech bubble.
2.The Fed may start tapering in November.
3.Hourly wages are rising quickly and this will bite into profit margins.
4.Raw material costs are rising quickly and that is inflationary.
5.Global economic growth is sluggish because of supply disruptions.
6.Electricity is being rationed around the globe due to energy supply issues.
7.China is seeing a rise in corporate defaults. This could spark credit concerns.
8.Analysts are downgrading earnings expectations at a fast clip.
9.This was the heaviest selling we have seen in a year.

There are enough dark clouds on the horizon that I did not expect a monster rally to unfold. After a heavy round of selling the last month I expected a more tenuous rally and an opportunity to evaluate and enter. In the absence of a credit crisis I believe that Asset Managers have no alternatives but to stay invested because bond yields generate negative real returns. On an as needed basis they hedge by shorting futures (instead of selling shares of stock). When the selling pressure subsides they buy back the short futures and the race is on as speculators join the party. Since Asset Managers are not selling stock, there is very little offered and buyers rip through what is there. That causes massive gaps higher on light volume. Corporations have also been aggressively buying back shares and that also constricts the supply of shares.

I still do not trust this rally for longer term swings. Earnings will favor tech stocks that have smaller payrolls (less of an impact from higher wages) and less exposure to supply shortages. The rest of the S&P 500 will be exposed to lower margins due to higher input costs and the guidance could be cloudy. In the last year when the market has come under pressure we rally back to the high and then the action dies down. I am expecting a fairly dull market this week with an upward bias. The FOMC next week will suppress the appetite for new longs. If the market holds the breakout next week after tech earnings and the FOMC I will reluctantly add some longer term exposure.

I have been doing so well with day trades and overnight swings that there is no reason for me to extend my trade duration.

Day traders should not chase the opening gap up. Gaps up to a new all-time high have often been faded in the last year. Wait for the bid to be tested. Stacked long red candles with little overlap in the first 30 minutes will be a sign that the selling pressure is heavy and that there will be a bottoming process. Be patient with your longs if you see this. Long green candles stacked on the open would be a sign that we are going to blow through the all-time high. I see this as less likely given the overnight news. If we get this move trim your trade size (I don’t like to chase at an all-time high). The most likely scenario is choppy trading with a mix of green and red candles today. Traders are going to wait for earnings. A gradual move higher and you can trade stocks that are breaking out through technical resistance on heavy volume and relative strength. A gradual move lower is our best scenario with mixed candles. The mixed candles are a sign that buyers are engaged and the drift lower gives us time to evaluate relative strength.

I am staying flexible and although I am looking for opportunities on both sides, I do favor bullish plays. I am expecting a dull day today ahead of MSFT and GOOG.

Support is at SPY $454. Resistance is the all-time high.

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