What to do Now that Stocks are Running

Talk about a relief rally. The S&P 500 put in its biggest move since 1974 after Europe announced several concrete steps to end the Greek debt crisis and protect the Euro-banks.

Of course, the plan has its flaws. Greece is allowed 50% default on bonds held by Euro-banks, but other investors will still be paid in full. In total, Greek’s debt-to-GDP ration is reduced from 180% to 120% by this deal. That’s a marked improvement, for sure, but it’s not a cure-all.

Also, the EU is apparently picking up 30 billion euro of the default tab. It’s not clear if that’s a lump sum payment to Euro-banks. Nor is it clear exactly how the EFSF bailout fund will balloon to $940 euro ($1.4 trillion). It appears at least some of that will take the form of asset guarantees and insurance, reminiscent of TARP, but the details seem to be lacking.

All in all, it’s great to have a deal in place. I expect I’m as relieved to be able to stop writing on this subject as you are to stop reading on it. But fair warning: there are still risks that something could de-rail the plan before it’s fully implemented.

Now, after yesterday’s impressive move higher, we should be examining how to play this rally. If you’re fully invested, then you can simply ride it out and enjoy the capital gains that I expect are coming. Like Jason Cimpl’s TradeMaster Daily Stock Alerts readers who were told by him on October 4 to invest very aggressively bullish.

If you’re not invested, or not invested enough, you should be looking to take advantage of the first sign of weakness to get positioned. There’s a very good chance that the stock market has embarked on a breakaway bull run. That simply means that there won’t be many opportunities to buy the dips, and that any dip will be shallow and short-lived.

We’ve seen this type of advance several times since the market bottomed in March of 2009. In fact, that rally out of the hole lasted over a year, and only offered one dip that was in the 10% range. The rally from July 2010 to May 2011 was a similar steady march higher.

I’d like to think the S&P 500 would take a breather and consolidate the gains we’ve since October 3, and maybe even make a retracement back to 1,250. But again, there are no guarantees this will happen. The forward P/E for the S&P 500 stands at 12.2, and it’s easy to imagine that money managers might simply pile into a stock market that looks cheap.

Basic materials — like metals and oil — have been leading this latest advance. Technology has been right there, too. I’m a little surprised that financials have maintained a leadership role. In the past, we’ve seen the banks start rallies out in front, and then fade long before the rally hit a high. But this time, they’ve stayed out in front, posting 8%-10% gains yesterday on heavy volume.

It’s times like these that it’s important to pay attention to the market’s actions and not let our biases keep us from opportunity. In other words, it’s easy to dismiss the banks as fundamentally broken with limited upside. But most of the bank stocks are 30% to 40% off their 52-week highs.

Heck, I’ve been adamant that cellar-dweller Bank of America (NYSE:BAC) was off-limits for investing. But I’m on the verge of changing that stance. A move back to tangible book value would mean a run of nearly 100%. And if the stock market moves like I think it will, the risk/reward for BofA is attractive.

I’d also have to consider Goldman Sachs (NYSE:GS) a candidate for a string move. I suspect Goldman’s dismal third quarter earnings report was one of those "kitchen sink" quarters, where the company took every loss it could find. That would set the company for much better earnings going forward.

And if Goldman dumps the bank holding company status, well, the upside is even better. Goldman is currently $60 below its 52-week high. I can easily imagine it making up half of that over the next month or so.

Finally, keep an eye on earnings for Chinese banks. Expectations are that earnings will be good for this group, even though growth has slowed a bit as China battles real estate inflation. China remains a potential bearish catalyst, and improved earnings for the group would be helpful for any rally.

Write me anytime at [email protected]. Have a great weekend,

Ian Wyatt
Editor
Daily Profit