Stocks too late now

Every morning the talking heads on CNN and Bloomberg come out with their smiling faces and try to come up with reasons to buy the market. Lately that's been a tough sell. I, on the other hand, have been bearish on the stock market for longer than I care to remember. There have been a series of supports along the way, at 12,400, 11,650, 10,725 and then down at 9,005, and at each level we would hold for a while, resulting in a chorus of "we've bottomed", until it became obvious that we didn't. Each subsequent retest would be met with a resounding "retests are bullish" and then we'd head lower yet. The last such critical level is at 8,146 and it was tested twice in October and held both times. This really inspired the bulls and they dragged out the big guns, like Barton Biggs, who took two days of TV time on numerous channels to declare a bottom for stocks and champion his love of the banking sector.

Well, a funny thing happened on the way to the bank; the December Dow futures contract topped out last week at 9,587 (on a closing basis) after six days of rallying, and then headed down. Currently it's 1:30 pm EST and the December Dow is down 265 points at 8,015 and has traded as low as 7,947 intraday. The last time we were down this low, on October 27th, we saw a bit of divergence at the close. The December Dow contract sold off heavily at 4 pm to close at 8,011 while the cash Dow closed at 8,175. This implies the cash Dow held support at 8,146 while the futures contract did not. Now we are facing a third retest (three red arrows) of the 8,146 support and I would expect it to break down either today or tomorrow. The

RSI, MACD, and the histogram are all headed down and we have now clearly broken down from the compressed trading range formed by the series of higher lows and lower highs. Also, with RSI currently at 37.50 there is no oversold condition and that makes it difficult to hold out much hope for a bounce.

I do not expect the Dow to go quietly into the night, and it will be volatile, so I do look for a rebound back up to the 8,160 to 8,200 area before we head back down. After all, Paulson announced big changes to his bail out aimed at increasing consumption, so he'll want to paint the market as best he can. What Paulson really fails to grasp is that cash put into the hands of the consumer will either be used to pay down debt or stuffed under a mattress, but it will not be used for consumption. Likewise, a proposed mega- stimulus package estimated at US $500 billion will do little or nothing to increase consumption. The simple truth is that neither the Fed nor Paulson can do anything to stop the deflationary cycle that has gripped the nation. It must run its cycle whether we like it or not, and that cycle will give us a gift to the short side of another 900 points and maybe even a lot more.

One of the few things that isn't losing any ground is the US dollar, and that seems to fly against all logic given the sizes of present as well as future bail outs and stimulus packages. Currently the December US Dollar Index is trading at 88.15 and, if that holds, will represent a break out to the upside (above the short horizontal blue line). Also, we can see that RSI, MACD, and the histogram are all headed in the right direction in spite of the fact that the dollar is now overbought yet again. We had very good resistance at the 87.32 level and that will now act as very good support. The next line of resistance is not until 89.78 and that represents a 38.1% retracement of the entire bear market decline, not an insignificant move to say the least. I am the first to admit that I am surprised by the dollar's strength. I knew that deflation would push the dollar higher over the short run, but I did not expect this much buying pressure. If I want to play the devil's advocate, I can say that deflationary pressure is a lot stronger than anyone would have anticipated and that's a bad thing. The same situation

applies to the bond market. We can clearly see the market top followed by a series of lower lows and lower highs, but deflation slows the decline as investors are caught between "safety" and the desire for higher rates in return for the increased risk. Sooner or later bond prices will fall, just like the dollar, but we probably need to see a decent bottom in the Dow before that happens.

[It's now 3:50 pm EST and I would like to switch back to the Dow as it is now up 550 points at 8,840 in a rally that is more short covering than anything else. Given the volatility that we've seen, you can't blame traders for hanging around too long. Sitting through the swings is hard on margin and the heart. We will see the close in five minutes and I assume the gains will hold but nothing has changed. All the Dow did is rally back up to within its trading range and I would not be surprised to see the Dow back down at 8,146 within a couple of sessions.]