Markets Signal Need for a Breather

U.S. stocks started the month with decent gains on Friday with the Dow Jones industrial (DIA) average up 56.99 points, or 0.46%, to end the day at 12,376.72. The S&P 500 (SPY) Index gained 6.58 points, or 0.50%, to finish the day at 1,332.41. Nasdaq (QQQ) was up 8.53 points, or 0.31%, to close at 2,789.60.

Friday’s payroll report from the Labor Department was considered the primary reason for the market’s advance. Nonfarm payroll employment increased by 216,000 in March, and the unemployment rate was little changed at 8.8 percent, the U.S. Bureau of Labor Statistics reported. Since November 2010, the jobless rate has declined by 1.0 percentage point, which seems to be the reason for enthusiasm amongst traders.

With the major U.S. equity indices visiting new highs (the Dow Jones industrial average is only 135 points away from its high), the optimism is palpable. Dow theorists have been suggesting buying into the recent rally, as they claim that further gains are ahead. On the other hand I think it might be the best time to take some money off the table. After all, the major U.S. equity indices have registered the strongest quarterly start to a calendar year in 13 years. But the recent advance in the market came on light volume, which is a reason to be skeptical that this rally will continue, at least for the short term.

The S&P 500 index has gained roughly 7% in last three weeks. Price action on Friday in the U.S. market was interesting to say the least. All three major indexes lost much of their steam in the final hour of trading, with the blue-chip index failing to close above its Feb. 18 finish of 12,391.25. The Dow scaled back after hitting an intraday high of 12,419.70, its highest level of 2011.

The week ahead will be another slow one for first-quarter 2011 earnings, with only two S&P 500 companies expected to report. The unofficial start of the earnings seasons is April 11, when Alcoa is scheduled to announce results, while the peak weeks begin April 18, which is after the options expiration week for the month of April.

In my opinion, the best risk/reward ratio comes from getting short exposure to U.S. equities. I recommend buying either puts on SPY and DIA. Or getting long ProShares UltraPro Short S&P 500 (SPXU), ProShares UltraShort S&P 500 (SDS), or ProShares Ultra Dow 30 (DDM). I would consider buying the April 132-131 bear put spread.

Disclosure: I am short SPY.