Monday, August 06, 2007

Market was holding its own into the weekend until Bear Stearns stirred the bears.

- Market was holding its own into the weekend until Bear Stearns stirred the bears.
- The interesting side of this volatility
- Will the Fed try to nip the credit problem in the bud?
- Taking the jobs report with a healthy dose of salt
- Rollover from a modest bounce paves way for another quick test lower, but will the Fed take that action?

Relief bounce short-circuited by Bear Stearns 'calming' conference call.

Stocks recovered Wednesday in a big way from further selling, making the shorts scream as loud as the longs prior to that bounce. Thursday was a modest but steady rebound, continuing the bounce back from the selling that took SP500 down to test its 200 day SMA. Friday started off modestly, but it continued the upside move as well with some back and forth trade that broke to the upside ahead of lunch.

Not bad as the market had to overcome some less than solid jobs growth and a weaker than expected ISM services report. Of course the jobs report was skewed: it reported education lower (summer break?) but no one believes there are fewer teachers out there. Thus the market saw through the lower numbers and recovered. Sure the sellers took their obligatory shot, sending the decent open to negative after the economic reports, but the indices set up an intraday reverse head and shoulders and bounced out of that weakness. Good move, but we noted in a midmorning alert that it was Friday, and the key for the market was how it held into the close on a Friday in a market with an inferiority complex.

Then BSC had its conference call, the one that was going to explain the problems with now its third hedge fund gone bad. It did that, reassuring analysts and investors the company had plenty of funds to ride out a 'perfect storm' of bad events. When an analyst then asked whether the company would buy back some of its stock, however, the CEO hedged, saying that the company wanted to preserve liquidity. Ouch. That was interpreted by many along the lines of 'if BSC won't buy its own stock then why should I . . .' It did not help that the reluctance to buy back shares was followed up with comments as to how the debt market was the worst it had been in 22 years (1985). Nice. Good job of allaying investor fears big guy.

Shockingly the market dove lower after those reassuring comments. The market had taken a lot of bad news with a lot of it coming out on Wednesday, the day the market sold but then reversed for gains. Looked as if it had taken its fill of bad news and was sold out. After Bear Stearn's left-handed 'assurances,' however, the market showed it could still sell out to the highest bidder, or indeed any bidder as the indices sold off at a 45 degree down angle.

Sell programs started to hit, and with no uptick rule in place anymore (used to be you could only sell shot on an uptick in a stock or the market) the selling snowballed. The programs built on one another, feeding the downside cycle. There was already a bias to get out ahead of the weekend, and BSC was the catalyst to go ahead and just do it. Equities sold off but bonds surged with a rush to safety. That drove yields lower with the 2 year at 4.50% and the 10 year down to 4.67%. Even a further peel back by oil (75.16, -1.70, down from 78.77 earlier in the week) did nothing to slow the selling.

Technical. As noted, the market was working on a third up side session (at least it covered 3 sessions) in what we anticipated to be about a week of a bounce. Then it reversed and sold off to close at the low. Poor intraday action and with the rollover that relief bounce was dumped. The charts show the story. DJ30 rolled back down through the 90 day SMA and closed at a new low on this leg. SP500, after rebounding from its 200 day SMA Wednesday, blew that apart Friday, closing 17 points below that key level. The large caps are in the midst of a major dive lower. Not that the small caps are any better, but it is very interesting that the 'time for the large caps' as many are saying sees those stocks as some of the hardest hit in the market. As for NASDAQ, well it still has some stocks showing relative strength, but it was not spared Friday as it fell back from the 90 day SMA and is set to test its 200 day SMA only 19 points further down. Of course volume was up and breadth was atrocious (-5:1 NYSE) as stocks distributed and the advance/decline line continued to roll over.

The move left DJ30 down 6% from its peak while SP500 and NASDAQ are both down 8% from their recent highs. Not major corrections but much lower than the spring fling. SP500 has corrected 8% from its peak hit in mid-July. That is the extent of its correction in summer 2006. DJ30 has faded 6% from its recent high; it corrected 8.4% in the summer 2006. NASDAQ at 8% is a piker compared to the 15% it lost last summer. Ironically, NASDAQ was a leading index heading into late July and looked to give support to the rest of the market. This last week put it in the ranks of SP500, however, and that index has been the weakest of the big three.

Another look at volatility.

That raises an interesting point regarding volatility. You cannot turn on a financial station without hearing about how volatile this market is. We have discussed it as well, noting in June that day to day volatility was on the rise with large point swings up and down occurring on the heels of one another. It was also rising as the indices hit higher peaks. Those are troubling signs for the market and they led into the current selling.

Volatility has also risen as judged by the VIX. Wednesday it just over 26, topping the summer 2006 highs. It was no slouch Friday, hitting a closing high on this run and it too topped the summer 2006 highs. The VXN, the NASDAQ volatility index, however, has yet to top the summer 2006 levels and it took the Thursday intraday blast higher to top the spring selling levels.

No big deal, right? Wrong. We noted NASDAQ was the leading index in the last part of the rally before the selling started. It eventually sold off hard, but at the same time technology has some leaders that are refusing to give up much ground. While SP volatility has shot past the prior levels on this selling, NASDAQ and tech volatility is no worse than it was in the summer 2006 or in the spring. What that means is that for one of the rare times in the market the SP500 volatility is greater than technology.

It rarely happens that SP500 volatility exceeds the more speculative NASDAQ. Typically it lasts for a few sessions. This past week it was for an entire week. This is out of whack and it is being caused by the meltdown in the financial sector on the sub-prime and credit contagion fears.

What this tells us is two things. One, this is an extraordinary event, not just a market pullback associated with a long climb that needs correcting. It was, but it has morphed into a massive fear of the unknown, impacting all financials and thus the SP500.

Two, it likely won't last. Historically these volatility events that see SP500 jump ahead of the other indices are short term. Of course you have to ask why. In some notable instances the Fed has acted as a stop gap. Why? Because the Fed is keenly aware of the financial sector of the economy, and if credit collapses the Fed knows the risk of recession triples. It also knows that you get hair-brained members of Congress trying to pass laws to 'protect' everyone (the most recent is Senator Schumer's bill last week) but they only worsen the situation by locking down the housing and credit markets longer than they would be if the market is left to its own devices. We talked about this in May, and it is laughable but for it being so sad that our esteemed leaders are going to make the same mistakes they have made in the past. Thus the Fed is pressured to step in.

By: Jon Johnson, Editor

Jon Johnson is the Editor of The Daily at

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