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Long time readers know that I have avoided a rah, rah approach to the market and laid out a veritable litany of dangers to be aware of in what has been a stupendous bull market. Even amid plenty of dangers it's still too soon to declare the bull dead, especially when a variety of negatives converged on the market yesterday and yet the bears could only push the market to finish lower by 2.3%, or more than 100 points above the lows.

2% market declines - how many of those have we had since the Dow was created - umm, maybe more than 900 2%+ down days?

So don't get me wrong. I'm not here to pump the market, or resort to silly hyperbole and say it was a 'bloodbath' yesterday and that it's time to gleefully buy with all available appendages. Make no mistake about it, these market down drafts are serious business after such an extended period time of rally, and if the negatives that have converged on the market become real fundamentals rather than speculative and psychological, the market will ultimately be slammed with a one day, thousand point-plus swan dive. It just wasn't that time today.

What I refer to as being speculative and psychological is the unknown of who is levered to mortgage paper meltdown and by how much. We know that every important player has some of this junk on their books, but we don't know who is going to be calling the NY Fed for emergency help in the middle of the night while we're sleeping. Another unknown is the shift that's occurring in LBO land where the banks are being forced to hold the paper since the corporates market is untappable. How many 'burning beds' are going to be out there and who's bottom line among the money centers is going to be most hurt? Another unknown is how the collapse of subprime and its spread into prime, etc will impact the economy as the debate rages between those who are sticking to a soft landing scenario vs hard landing. Certainly Bernanke did not help the situation and really exacerbated it when he sliced a quarter point off of economic growth potential this year during his Congressional testimony. There is little clarity on a variety of issues, and the previously intrepid trading community which has racked up huge gains, has decided, and I think smartly so, to look at the glass as being half empty for now.

We know in no uncertain terms that the mortgage market has come undone and that high yield corporates market is getting pummeled. ABX BBB-07-02 slid to 40 yesterday and 07-01 tumbled to 37. AAA 07-02 fell to 95 and 07-01 slid to 92. LCDX tumbled to 93 with the spread widening to about 350 basis points. Still, we don't have clarity on who's going to be taken down and that opaqueness simply feeds the negative psychology we've been seeing.

While the point decline was large looking and internals were ugly (including extraordinary volume accompanied by just as extraordinary negative breadth, etc), this was hardly a panic day. The TRIN yesterday managed only to rise above 4 level - that's not the type of fear that marks a capitulation day.

trin

I'd say that on a short term basis the market has become rather over sold and with the VIX for a while soaring above 23 (up 27% intraday) and even surpassing the VXN today, it's likely we'll see a dead cat bounce early next week. Will market participants wish to make fresh bets with alacrity on Friday and get the bounce going ahead of the weekend? Many have been conditioned to buy on the dips and today's lack of panicky feeling and indications out on the blogosphere that a variety of folks are feeling it's time to do a cannonball back into the pool are an indication the conditioning has not been changed - because there hasn't been a REAL panic to change that conditioning. So while it's hard to imagine strong buying pressure on Friday, you just never know. GDP at 8:30 may seal the fate of the tape early on.

Here's a picture of the VIX (red broken line) and VXN (solid line) where it's plain to see that its not everyday that the VIX spends time above the more volatile Nasdaq VXN. FWIW, back in late 2005 when the VIX exceed the VXN the market kicked into a strong late year rally.

vix

On the S&P we've slammed down through a variety of support areas and it was an impressive feat on the part of the bulls to keep SPX from slicing down to 1460 and to get it back above 1480. 1500 now becomes an area that needs to be re-broken to the upside first and then the same intermediate 10 point upward steps will need to be retraced. So my objective is going from 1600+ back to 1550, continuing to be conditioned on the need for meltdown conditions not to develop. If today's intraday lows are broken in the near term, you can sure bet on a repeat episode of what happened when Tuesday's intraday lows were busted.

This weekly chart of the S&P is interesting to me from an RSI standpoint. If weekly RSI slides below 50 again then I would be looking at this market in a much more bearish way. We'll see.

spx_week

I started my post with a mini diatribe directed at the bears for failing to keep the market near the lows amid a variety of negatives. The biggest negative that I've been seeing in the market is the rebound of the Japanese yen. I find it faska-nating (hat tip to Popeye) that the Dow peaked at 14,000 as the yen managed to break above 82. Folks, this isn't psychological - this is a very real fundamental and extremely negative for the market. Carry trade has funded all strata of speculative activity around the globe. When carry trade is unwound, a variety of asset classes suffer, including U.S. stocks. Keep an extra close eye on this. If the rumor mongering about subprime/credit market black holes turns to a real event, or is quantified with some additional real numbers while the carry trade continues to be unwound - the bears will have the right combo of factors for a real market dislocation. This chart shows the Dow (solid black line) and the yen (broken line).

carry

Source: 2% Market Decline - That's It?