The Bull/Bear Debate Rages

Breakdown or Support? The Next Major Test

By Bryan Bottarelli
Monday, June 23, 2008 10:47 AM EDT
Mon, 23 Jun 2008 14:47:00 GMT

Dear Bottarelli Research Member,

Good morning! As we kick off another trading week, I can’t remember a time where I’ve come across such dramatically different viewpoints of the market.

On one side, you have the bears, who think that the U.S. sub-prime catastrophe will trigger a global bear market in equities, causing a “global meltdown” that affects every market — including red-hot countries like Brazil, Russia, India, and China.

On the other side, you have the bulls, who argue that the major market averages (while down 9% on the year) are still only 19% below their historic, all-time highs. In the context of a bull market correction, that’s certainly a reasonable pullback, especially considering all of the horrible news that this market has withstood.

As a quick review, the truly “bad news” started in January, when the trading patterns at Societe Generale raised global concerns about our banking structure. Then in March of 2008, we witnessed the implosion of Bear Sterns, and here in June, we just had a “scare” with Lehman Brothers. This all came at a time when virtually every major bank stock dropped so low, they’re now trading below book value. And of course, we also have a housing market that’s in the soup — plus tremendous intra-day volatility sparked by runaway oil and food prices. Yet despite all this, argues the bulls, we’re only 19% off our historic highs. All things considered, that’s quite resilient.

Ok, so enough of the 2008 review. The big question is, “What do we do right now to profit?”

To be honest, I think that we continue our strategy of carefully playing both sides of this market via calls and puts. On the bullish side, short interest on the NYSE is approaching record levels — and this could lead to a major short-covering rally. If we witness such a move, we’ll be in fine shape with our calls.

Furthermore, I still believe that oil stocks (like COP) and steel stocks (like STLD) will allow us to withstand any weakness. In fact, Barron’s just ran a cover story arguing that oil prices could correct back to $100. But even if they do, a company like COP will still be in fine shape. After all, their 2008 P/E of 7.9 is dirt-cheap. And their 2009 earning estimates were based off $100 oil prices to begin with! So in terms of COP’s forthcoming earnings, anything above $100 oil is simply gravy.

Another sector that’ll remain strong is agriculture. Some experts are saying that current corn prices (despite their recent increases) still only equate to oil at $40.00 a barrel. At the same time, these experts also predict that food prices will continue to rise 9% per year from now until 2012, and that sure is a strong tailwind for increased upside movement. (*it’s also a bearish catalyst for a food company like CMG, making our puts look like a nice position)

The bottom line is this: Whatever direction the major market averages decide to go, we’ll know exactly how to play it. In terms of our current trading, as you can see from the Dow chart below, the Blue Chips are currently making a feeble attempt to find support close to the March 2008 lows.

INDU

At this point, it’s completely unclear whether we’ll see a support point of a full-blown breakdown. So until we have further clarify, let’s remain holding our CMG July 90 Puts (CMG SR), COP July 100 Calls (COP GT), and STLD July 40 Calls (RQL GH).Should any upcoming trading action trigger, you’ll be the first to know. Until then…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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