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Morning Update

Overnight news out of Europe once again is full of lowered expectations of future growth. The Bank of England, in its quarterly inflation report cut its 2012 GDP forecast to 0%. S&P placed Greece on negative watch, noting that it may need additional funds from the Troika. S&P also lowered their expectations of Greek GDP from a 4-5% contraction to a 10-11% contraction in 2012. There was pressure on Spanish bonds overnight as Spain changed its deficit target to 4.5% from 3.5% of GDP. Spanish 10-year bonds now yield 6.44%.

In the US, the market looks to be on track for a modestly lower opening. Yesterday after the bell PriceLine and Disney reported earnings misses. We believe that the market looks toppy here and could see a short term decline. One reason is that despite the S&P 500 being up the last two days, the VIX has been up as well. Typically we see the two move opposite to each other.

A rising VIX in a rising market means that traders are buying options to protect their portfolios from a decline. This indicates that there may not be many buyers at 1400 in the S&P 500 to continue pushing the market up. We recommend using $SPY August and September put spreads to reduce the impact of a market decline on a long stock portfolio. For example, with $SPY at 140.30, you can buy the Aug. 139 put and sell the Aug. 137 put for $0.45. Should the market decline and close below 137 at August expiration the trade makes $1.55 on only $0.45 of risk.

In uncertain markets like this investors should stick to quality stocks and only take trades with the best risk/reward ratios.

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