- Good start to the week and the relief rally, but that bounce was rolled by more European and US economic worries.
- Friday finds stocks back down at the summer 2010 base highs and last week’s lows.
- JPM and Citi join the party, and MS, in downgrading the US economic outlook.
- Second test of Summer 2010 base: double bottom or a continuation of a new rollover?
- Ready to play a second bounce, but as a setup for more downside.

MARKET SUMMARY

Stocks are back where they started two weeks back, trying to put in a second bottom.

Stocks ended the week where they found themselves two weeks ago, sitting on top of the Summer 2010 consolidation base. That inverted head and shoulders was the springboard for the two legs to the upside into January of 2011. Of course, that was aided by QE2 that Bernanke announced after his Jackson Hole summit in late August. Lo and behold, on Friday next week there is another Jackson Hole economic summit by the Federal Reserve chairman. Many people are looking that way for some salvation for a market that has given up the entirety of that run off of the QE2 implementation.

It was a good start for the week. On Monday stocks blew through the 10 day EMA. They looked to have broken free, ready to continue a nice relief bounce either to that November peak or all the way up to the March and June lows at 1260 on the SP500. It was not to be. Even though there was some poor economic data on Monday with Empire Manufacturing coming in negative yet again, the market still managed to rally. Tuesday is where it ran into trouble, however. It reversed but it did not totally give up the move.

What was the problem? More economic data. Housing Starts were not good, but Industrial Production and Capacity Utilization topped expectations and were at levels not seen for two to three years. There was improvement there. Nonetheless, the market met its old nemesis, and that would be the problems with Europe. Europe is teetering on the verge of collapse. Germany may be the only one left standing in terms of the economy. That would be kind of ironic. I know no one wants to hear it, but history has a great sense of irony sometimes. In World War II, Germany tried to take over all of Europe and basically the rest of the world. Now, since it went through all the austerity measures before anyone else, its economy could be the only surviving member in Europe. I know the times and the motives are totally different, but if you are a student of history, you will notice the ironies.

It is also ironic that the U.S. is trying to pull out of its recession (I call it a depression) by using the same tactics that prolonged the 1930′s depression and the 1970′s recession. They like to call this the Great Recession, but it is really a depression. It will turn into a longer-term depression if we continue to implement these policies. But all will be well. We all know that President Obama knows what to do, and he will tell us all about it on September 5th or thereabouts.

Herman Cain, one of the Republican presidential hopefuls, has an interesting plan that he calls 9-9-9. He wants to reduce taxes for individuals and corporations to 9% and he wants to implement a 9% sales tax. I am not sure what the other 9 is. The ultimate goal is to eliminate the income tax entirely and put it all into a national sales tax. It will be interesting to see what the President comes up with. As we all know, it will basically be a political campaign ploy versus a real attempt to help the economy. Some will say I am cynical, and some are saying I would rather see the economy go down. That is not true. I just know what the President has said in the past. I know his past, and I know what is most important to him based on his actions and what he has said. I am not going to attribute anything to anybody that their actions and speech do not warrant.

After that digression, I will turn back to what happened on the week. Wednesday we had the PPI, and it was hotter than expected. Look at that core, jumping up 0.4%, twice what was anticipated. Thursday was very important data. Jobless claims are back over 400K no surprise there. The CPI was up to 0.5%, more than twice expectations. Existing Home Sales were terrible. Really plunging. The Philly Fed was -30.7. Manufacturing is in trouble. We all know manufacturing helped lead the economy out of the recession. Although, when you look at it, manufacturing was it. That was the zenith for the recovery, and it was all aided by the liquidity.

The market figured it out. It is worried about Europe, it is worried over just about everything economically, and it sold off. Again it finds itself at those August 2010 peaks, trying to hold. It is also above the August 2011 peak. There are possibilities here. Indeed, there are some very smart market players out there who believe the market is putting in a double bottom and will bounce off of this. It is definitely a “scare them out” market versus a “wear them out” market. There are dives lower, big spikes to the upside, and dives back downside. It definitely had the extremes hit on breadth, on new lows, on the VIX, and on the put/call ratio. You name it.

The bulls versus the bears are basically unchanged, and I find that totally shocking. I read this in Investor’s Business Daily. Bulls levels are at 46.2% (47% the prior week), and bears were flat at 23.7%. Not a budge even with all the negatives.

Friday the market failed to find any traction yet again. It started lower. There was no economic news released, so it was just falling of its own accord, but it did reverse. All of the indices traded higher in that first hour and a half, looking solid. But that was it, and they could not hold the move. They sold back and continued to bleed off the rest of the session. They closed with losses once again, and they were again back down at that early-August low and the summer of 2010 highs.

NASDAQ, -1.6%; SP500, -1.5%; Dow, -1.6%; SP600, -1.5%; SOX, -1.8%.

It was a pretty good licking’ once again. Some commentators noted and this was true and humorous in a macabre sense that this was this was not much of a selloff compared to what we have seen of late with the volatility. It is sliding down to the prior lows just to get out of town ahead of the weekend. I felt there might have been some short covering coming. It started early in the morning, but it could not hold. It had been a whopping downside week, and I felt the shorts might not want to be short over the weekend. I guess they figured there is more chance of a bad news story coming out of Europe than there is of something positive coming from anywhere else in the world.

Accordingly, stocks slid down and closed at the session low. Interestingly, JPM and Citi joined MS in saying that the U.S. economy was cruddy and heading lower versus improving. JPM reduced its Q4 GDP estimate to 1% versus the 2.5% forecasted prior. The Q1 of 2012 was reduced to 0.5%. Took them long enough. Things are definitely not improving, and there is little hope of improvement. That is the key looking ahead. Markets forecast into the future, and what hope is there of improvement?

Leading Economic Indicators may have risen for July, but those indicators are notoriously incorrect. The ECRI does not look as rosy as it has in the past. It is turning back down as well. When you see the trends, there is nothing to really promote rising stock prices. Yes, there are profits in large corporations, but they are holding that money. There is no reason to spend the money given the policies in place, and that is something we have seen many times in several episodes over U.S. economic history.

When there is no reason to spend the money because the risk/reward is not there (due to regulation, government intervention, etc.), the money is not spent. It has time, and it waits for a conducive environment. Maybe it is Herman Cain’s 9-9-9 plan or something like it that will unleash it. I guarantee you that infrastructure spending, pump-priming projects, and repackaged Keynesian ideas are not going to work. I was texting back and forth with some colleagues today, and I posed this question to all: Is this economic performance the last bit of evidence we need to once and for all debunk Keynesian theories and forever throw them on the scrap heap of economic ideas? To a man and woman, they all said yes. This has proved again that it does not work.

The market is not showing any reason put in any kind of sustained rally. It has to have something positive to factor in. It may bounce from here. It may very well be a second bottom. I have talked about how I think the market could rise back up from here with, for example, SP500 rallying near the 1260 level. Or maybe it takes out that November peak but tops the recent high it rolled over from this week, forming that downside ABCD pattern that leads to more selling. We will see. I think there very well could be a bounce from this level. It is a key level with the very extreme indicators that were shown the past two weeks in terms of new lows, breadth, volatility, put/call ratio, and fear levels in general. I think it could put in a bounce here and make that little double bottom. I do not think there will be a breakout of the range. I anticipate a rollover and further selling back down to (or through) the bottom of the 2010 base.

MONDAY

There is more economic data, although none of it is heavy hitting like we had this week. We have New Home Sales on Tuesday. That is important because we had Existing Home Sales the week before and they were terrible. Durable Orders are out on Wednesday. We have Jobless Claims once again on Thursday. Hope springs eternal; they have them back down to 400K with the early expectations. Then you have the second read of GDP on Friday. It is expected to fall, showing now at 1.1%. That might be a bit optimistic. Things have not picked up; they have gone the other way. I do not expect anything major to the upside.

I want to look at SP500 again because it summarizes everything pretty well. On SP500 we are looking to see if there is a second bounce to play next week. I said if the market failed at the 10 day EMA on this bounce that it would indicate that things were extremely bad in the U.S. economy. Maybe worse than I figured or maybe not. I did not think it would be good in any case. It has failed at that point. The question now is whether the indices will just break through the prior August lows and down into that 2010 base.

If they go straight down from there, that is not good at all. If we bounce higher, it is not necessarily good either, but we can make an upside play out of it. A drop from here does not do us any good. We cannot really play a drop from where the indices closed on Friday. There has already been a big gap lower on Thursday that took a lot of our plays out of contention. That is unfortunate because there were some grand setups. At least we got into some of them. We took some good gains on Friday from some of our downside positions, such as FOSL. It sold early and we took some nice gain off the table. We took some gain off our new LLL position. We finally locked down the rest of the WMBD because it did not look like it would break lower in its pattern. We also look some gain on RAX. EMN was one we just entered. We took some gain there as it sold off but looked like it was holding.

We banked some nice gain on the positions we did get into, and we could have gotten into a dozen more. We are making excellent money on these to the downside. But as I said, it is not necessarily a great place to enter new downside positions. We have to let them set up again. Frankly, the best bet for that is the ABCD I am talking about with the D point coming up somewhere around 1250-1260 on the SP500. We will be watching for that. I anticipate a bounce here. I may be totally wrong, but the indicators were so extreme that this bounce has not unwound what they have done. I think the rubber band is still tight, and they could bounce up one more time before they dissipate and roll back over.

That is what we will be looking to play. Again, if it breaks lower from here there is nothing we can do. We will just have to say “oh, well” and let them set up again. On any bounce we will look for the name brands that I talked about in the leaders and will play those to the upside. We will do the same thing we have done before. As the index moves higher, we will be taking some of our downside off the table. We will start moving into the downside as the move starts to peter out. We cannot wait until the total breakdown comes. We will do what we did: pick up two or three a day to the downside. Then when it breaks we will be well-positioned to take advantage of the fall.

Not a rosy prognosis at all about the future or for the market necessarily. The thing we need to focus on is how we make money in bad times as well as good times. These would definitely qualify as bad times, but we still have to focus on making money. We have made a lot of money during this market volatility. We have had to eat some positions, and that is not fun. We also know they are not necessarily out of contention. With the volatility in this market, things reverse rapidly both upside and downside as we have seen. We have made money on certain positions that maybe we were damn lucky to. Look at the QID position that we had a while back. It gapped away from us and got down, but when the market sold off we ended up making over 70-80% on that position. With this kind of volatility, you will get under water somewhat with the big gaps, but a lot of times it will bail you out.

Mind your positions the best you can. Maximize the gain, minimize the pain, and we will be just fine. We will ride this through as we always have, and we will come out on the other end with more money than we realize. When you look at your account, hopefully you are seeing what I see and it is performing quite well.