Breakout

ECB Plan Sparks a Blue Chip Rally

Jeff Macke
Breakout

Stocks are rallying sharply Thursday in response to the latest iteration of a European Central Bank rescue plan. As laid out by ECB president Mario Draghi, the central bank will begin purchasing the bonds of member nations on the condition that the countries submit to outside fiscal oversight. Dubbed "Outright Monetary Transactions", or OMT, the program would be transparent, strictly conditional and designed specifically to reduce catastrophic meltdowns caused by spiking yields.

To which market bears are saying "so what?" OMT is just another program by another central bank. It's a promise to do something without actually doing it, much in the manner of Quantitative Easing 3 in the U.S. As skeptics see it, this is barely worth discussion let alone cause to take the S&P500 to 52-week highs.

"This is an excellent opportunity," says Tom Kee, editor of Stock Traders Daily, setting the hook, "if you're on the short side of the market." Kee says that once the excitement fades market players are going to see the extraordinary degree to which the market is overvalued and head for the exits.

"The Dow Jones Industrial Average year-over-year has negative revenue growth and, if you back out share buybacks, negative earnings per share growth," notes Kee. He's right, of course, but earnings haven't much mattered to the rally thus far in 2012. As Paul Hickey of Bespoke Investment Group noted last month, 2nd quarter earnings in the S&P500 were the worst relative to expectations since Q1 of 2009. The index has risen more than 7% since the beginning of July, regardless.

Any improvement in the ECB is apt to throw a monkey wrench into the bearish view. Earnings in the U.S. are slumping in no small part due to global economic weakness. Even with China slowing precipitously, simply slowing the rate of decline in the European economy would be enough to raise the earnings outlook for the vast majority of corporate America.

Stocks are moving higher because investors large or small are moving off the sidelines are rushing into the market. Buying is across the board with old school blue chips like Disney (DIS) and Smuckers (SJM) pushing to all-time highs, and Hershey (HSY) nearly there. No one got caught short a jelly company. Hedge funds haven't been leaning against chocolate and Avengers. This is actual organic buying by slow-moving participants.

Kee would be a seller of stocks here. If support at 1,400 on the S&P500 breaks he'd be ready to get aggressive on the short side until stocks move back into what he views has a reasonable value relative to earnings growth.

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