The Day (and week) that Was - July 28th 2007

The market got bad, then it got real bad. Sub prime problems have moved into the prime and corporate lending arena. A threat to prime lending would slow down large corporate buyouts as the necessary funding will become too expensive (and difficult) to obtain. The markets have been fueled over the last 18 months by the large M&A activity. A slow down of the M&A will only add to the already uneasy market. That is what happened Friday.

The growing fear is that the housing sector and financial sectors are no where near a bottom. And a failing housing sector is another indication of a slowing economy. I believe that the housing sector has a long way to go before it recovers. Today I asked around my town where I live to a few people selling their homes and have been on the market for many months. The reason that existing homes are selling so poorly is that the value that the sellers feel the home is worth is far above what buyers are offering. What could have sold for $300K a year ago is today getting offers of only $225K. And the sellers keep waiting for an offer that is closer to what they feel their home is worth. But the bigger problem is that as the economy weakens people will be offering even less. So home sales will continue to drop until a balance can be achieved between the sellers and buyers. When that happens home sales will begin to go up but the average home price will be lower, the lowering home prices will add to signs of a weakening economy. It becomes a domino effect. One other issue compounding this mess is that the problems with the sub prime (and now the prime) lending issues will put tighter restrictions on mortgage lenders and who they issue a mortgage to, further adding to the housing sector free fall.

All of this hit the market in a swift one/two punch this week. A wake up call if you will. The market was already on uneasy ground (remember I posted a yellow flag for the market a month ago- that was because I saw the markets losing their momentum) and this one/two punch sent the markets down for the count.

Can the markets get up before the count reaches 10? Can the markets be like Rocky Balboa and come back fighting hard in the last round and win? I wish it were that easy. The markets are indeed firmly in a transition stage. The big question is if the transition is into a mild pullback or into the next bear market.

On Friday morning President Bush made it a point to have a meeting with his financial advisers. In a video tape released by the White House the President could be seen sitting with his advisers and in the background were charts which predominantly showed graphs going upwards. As if to put on a show of how great everything is with the economy. In my often suspicious view of things (it is my nature to question things I am told) I see the the appearance of the President on Friday as a sign that things are worse then they want to admit. And you know what? The market felt the same way! After the President's remarks the market just got worse as the day went on. The smart money saw right through those charts behind the President and looked at the real market charts. And those charts are showing an economy that is turning sour. And that is why we saw the big sell off on Friday. Do I think a recession or a bear market is coming? I don't know yet, but the market is fearing it more and more. Remember it is fear and greed that moves the markets - nothing else.

Now for some more charts: (Click on the charts for a larger image)

The Dow Jones Industrial Average closed right at support. Any move below this key support level will take it down to the fib retracement at 13000. If that fails then we are likely to hit 12750.

Materials which have been been rock solid since 2005 has also come down to a support level. And a failure of that support takes it back down to the 35 region as shown on the chart. A bigger decline in the materials sector will weight heavily on the major indices and will add to the weight of pulling them down as well.

The NASDAQ has fallen below support and were likely to see 2460.

The S&P 500 has closed right at a support level. If the S&P can gain a little ground then it will hang around between 1461 and 1484 until the market decides which way will be the future course of events (bull or bear).

The VIX (volatility index) hit another 52wk high on Friday. Not good.

Now another chart of interest is the QID. The QID pays you when the broader market goes down. It is an ETF that can be traded just like a stock. What is of interest here is that the volume has been increasing since last March. Smart money has been slowly building up a position in these types of ETF's to get ready for a possible bearish winter coming. (Note: volume does not impact price on an ETF. It is solely a measure the shares being traded)

So what do we do? We play the charts. Just like I always do. When I see a chart that looks like a good play then I will play it. The plays are harder to find in this current market environment. But I will keep looking. There will always be something that goes up even if the broad market heads down. If you have a long term investment account (IRA, 401K, etc) you might consider hedging (Making an investment to reduce the risk of adverse price movements in an asset or assets) your account by adding a position in an ETF that shorts the market such as the QID I highlighted above. There are many others such as SH, SDS, TWM, SRS are just a few examples of ETF's that can be bought and sold just like a stock but they increase in price when the market they mirror goes down. By adding one or two of these types of investments to your long term portfolio hedges against the decline in your other stocks you hold for long term. If you want to learn more about these types of ETF's check out the company that issues them: Proshares

Monday we start a fresh week. We are likely to see a bounce in the broad markets with so many charts sitting right at support. This would not be unusual. What happens with these bounces will be the key into knowing where we are going. If any bounce continues to be sold off then the fear continues to be the dominating emotion driving the markets.

See you on Monday Rebels..