- Tuesday’s bounce is Wednesday’s renewed selling: with nothing new in the world and just the old problems, stocks lose their bid.
- Rumors of a France downgrade raise the same old fears, and the sellers’ boldness, again.
- Goldman says “a greater than even chance” the Fed will reinstate QE by the end of 2011 or early 2012.
- Gold overcomes the topping signal, gapping higher on European worries.
- Some asking ‘where is the recession?’ The market is starting to provide an answer.
- SP500 50 day EMA crosses down through the 200 day SMA.
- Market CAN rally from this pattern, but after giving up the relief move it has to find a reason.

MARKET SUMMARY

SP500 rallies 50 on Tuesday, sells 50 on Wednesday. Rubber match ahead.

Stocks gave away Tuesday’s gains as easily as you take out the trash, though at my house getting the trash out via the kids can be a chore in itself. Wow, digressing right off the bat. Once again it was the push into the close that really stung. Tuesday it was big push upside into the bell. Wednesday it was a big push downside into the bell. 50 up, 50 down.

After the extremes hit in sentiment indicators and market internals the market is primed to bounce. That makes Thursday the rubber match. If the market cannot bounce after these extreme levels were hit, even a week long relief move that ultimately fails, there is something very, very wrong that the market is pricing in.

I heard Larry Kudlow as the question tonight “Where is the recession? Where is the recession?” He cites corporate profits as proof there is no recession. Mr. Kudlow is apparently forgetting his roots in the Reagan administration that championed small business and American ingenuity and entrepreneurship. Small businesses, as I have discussed often, are getting crushed by the Administration in so many ways. It favors the large corporations that sell overseas by giving them billions in stimulus for free, subsidies to protect their markets, and guts the dollar so they can sell to foreign markets. It inhibits energy production, driving up energy costs for the small guys. It forces those insurers catering to the small businesses to drop coverage plans (already happening in several states) because they cannot make it work with the 85%/15% premium payout to profit ratio imposed under Obama-care. Small businesses are shutting down every day because their margins are so squeezed they have to turn elsewhere to make ends meet.

The Market Knows . . .

I will tell Mr. Kudlow, Mr. Market, that he is also forgetting his own theories. When the stock market is diving lower it is telling you something is wrong. The market gave up the entire QE 2 rally in 1MONTH after the program ended. It took one month to give up the entire QE2 rally. I had to repeat that. It was, as I have said for months, ALL LIQUIDITY driven. Without the liquidity the market dives. There is nothing in the future for stocks to rally for. With small businesses closing right and left, the major driver of US wealth creation and job creation is dying as we watch. The stock market is not selling EVEN THOUGH corporate profits are so strong according to Mr. Kudlow.

The bond market is not stupid. Many cite the yield curve as showing there is no recession ahead. Of COURSE IT IS a positive slope: the Fed is holding low end rates at 0%. The 10 year is racing lower, closing at 2.09% (!!!) on Wednesday. If it could it would surpass the 2 year which is now virtually charging buyers to hold their money. The Fed is creating an artificial positively sloping yield curve. Bonds are surging higher because of fear just as stocks are selling because of fear.

The gold market is telling the story as well. Fear is driving it higher. Fear Europe will fail. Wednesday the rumor was France was to be downgraded. That is the second largest economy in Europe. Nice. Fear that US retirement accounts will be gutted. Fear the economy is being irreparably harmed by the current powers. On top of the fear, the Fed said it will keep rates at 0% for two more years minimum. That further sews the inflation seeds and thus fuels gold’s surge. When it reaches the tipping points bond yields will move explosively higher if the course is not corrected.

The markets are screaming that something is horribly wrong not only in Europe where everyone wants to hang the albatross, but here in the US. If profits are so strong and things are so solid, why are the markets in turmoil? Those that fear markets say the big money is rigging the game. I can tell you that even with the program trading that makes trades in nanoseconds the results are the same: greed and fear still dominate. The moves are the same whether man or a machine that man programs makes the decisions. Markets represent the aggregate of all views on the economy. They take all into consideration and distill it into prices. Mr. Kudlow and others denying this are falling into the old trap of believing they are smarter than the markets.

Of course Kudlow and the others are in good company. The President believes he is smarter than his political and economic advisors; he has told reporters this and they have duly reported it. How incredibly dangerous this is. People convinced they are smarter than everyone and everything else. It leads to bad endings. Enron comes to mind. That debacle ruined the lives of many and it was just one company. The stakes are much higher here. We are talking about the world’s leading super power.

It was all liquidity and now the liquidity is gone.

The markets are telling us the entire move from the lows in March 2009 was liquidity. There was the appearance of recovery thanks to the rising asset prices and some wealth expectations pushed some capital investment and some demand. When the initial QE program ended in Q2 of 2010 the market pitched into a selloff dropping SP500 16%.

QE2 was announced at the end of summer and the market embarked upon a 2-leg, eight month rally that grew SP500 by 32%. When the Fed did not re-up the QE2 program at the end of June 2011 the market, to the day, started to sell. It sold off but managed a rebound in late June to early July. It put in a lower high and then rolled into the selling the past two weeks. A 20% plunge in not quite 3 weeks. Liquidity gone, the gains built upon that liquidity are gone.

Now everyone is looking at the Fed to see if it will try another version or round of quantitative easing. The economic data has declined since January this year. I wrote about this extensively during the first half; it was clear the economy had not ‘caught hold’ during the liquidity binge. The dive lower once the liquidity pump was turned off tells the tale.

If the Fed does not step in the market likely gives back the entire upside move off of the March 2009 lows. The Fed punted the ball back to Congress and the President, wanting some change of policy to help the economy versus just adding more inflation-generating liquidity. This President’s idea of stimulus is raising taxes, including those in the small business range of incomes, adding another level of attack on this most important segment of the US economy. Congress won’t pass anything that resembles spending (and many in Congress call allowing citizens to keep more of their money ‘spending’), so there is likely no help there. It will take just about a complete economic collapse to bring about change, and then the Fed will be compelled to step in and do it all over again, creating credit in hopes that creating more credit will solve a problem caused by creating more credit. Indeed, Goldman Sachs stated Wednesday that the Fed had a ‘better than even chance’ of renewing some form of quantitative easing by late 2011 or early 2012. It is a very, very tough circumstance given the ideologues in charge of the country.

THURSDAY

The Wednesday action was not positive for a further rally but it did not kill it off either. As noted regarding sentiment, after the extremes are hit it takes several sessions to gel and turn the market. The action Wednesday was not great, but it did not violate the prior lows and the indices are holding key support. Markets have rallied off of this action before. If they fail, it is a repudiation of any sense of economic sustainability as a result of QE2 and next would be QE1.

Given the action we still are looking at some upside. Yes the 50 day EMA crossed below the 200 day SMA on SP500, and that does suggest further downside to come. There are some solid stocks in good position to run higher, not to mention the indices themselves, and they are still likely to bounce higher before really tanking again. Question is, is there a reason for them to rally, even in relief? I still look at the extreme indicators and know that a bounce can still emerge. Knowing it can doesn’t mean it will, however.

Thus while we have upside plays ready to go we also have to look downside as well. If the market wants to collapse, while it is not the best risk/reward position to the downside, a collapse due lack of faith can be just as harsh, and these plays we are looking at have bounced, have room to fall, and thus can make us solid coinage on a further market decline.

I would lean toward a further bounce despite the Wednesday selling. Years of trading, however, have taught me that I cannot hold up the market just because of my bias. Thus we here in the office trading room are going to be ready either way on the ‘rubber match’ coming Thursday and likely Friday as well.