Bears Continue To Look Strong Despite Lack Of Concrete Catalyst

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Includes: DIA, QQQ, SPY
by: Jason Cimpl

The market was clobbered last week. Most of the Majors lost 5 percent, while risk indices like the Russell 2000 lost seven percent. Volume was noticeably low, though that was expected given the holiday in the U.S. But the bears continue to look strong despite a lack of a real concrete catalyst (like dismal fundamental data).

Risk aversion has taken hold of the market as investors became fearful that Europe will implode and that China's economy will begin to slow down. A key gauge of economic activity in China did register an unexpected decline in manufacturing production last week.

Up until that point, however, there had not been much to indicate that the Chinese economy is headed for trouble. But Europe is also a concern for investors, and any slowdown in China would add salt to the wounded economy. Europe is bordering on a recession. But the ECB holds the key to its own recovery - it can still lower interest rates. The central bank could also call for more money to be printed and become a lender of last resort.

Should the ECB decide to take the U.S. route and elaborate monetary easing, inflation would be a concern. While the U.S. has not registered high inflation since it embarked on quantitative easing, I dare say prices have fallen. Also, the EU and ECB, along with the Germans, have been much more fearful of inflation than the U.S. has been over the past three years.

However, if inflation can slow down in the EU, the ECB may decide to try and stimulate the economy through monetary easing. And the inflation trend in Germany will have a huge impact on what the ECB can or cannot offer, which makes Tuesday's CPI data from Germany especially important. Additionally, producer prices for the EU in October will be announced on Friday.

The economic data in the U.S. is somewhat mellow this week; although the nonfarm payroll data, along with the overall unemployment rate, will be released on Friday. I think the ISM manufacturing data on Thursday is more important, however. Investors are numb to 9 percent unemployment, but the market would panic if Thursday's ISM registered a number below 50, which indicates a contraction.

Most savvy investors understand that the ISM number becomes a closely watched gauge for economic health towards the waning period of a boom phase. The U.S. economy has been in growth mode for two years. And if its economic growth is to slow down in the very near term, the ISM (manufacturing) would show a contraction in activity before GDP does.

The ISM manufacturing data represents the sentiment toward prices paid and labor wages. Since inflation and wage growth are critical components to a healthy economy, the subcomponents of the ISM manufacturing survey can tip you off to economic trends like employment and inflation before official government data is released.

The market's decline over the past week has been far more severe than I'd forecasted. In hindsight, fast money could have been made to the short side of the trade. While we were in cash for the bulk of the decline, it would have been nice to post a few winning bearish trades over the last week.

In reviewing the chart, I'm not sure I would have traded it any differently, even with the benefit of hindsight. The bears clipped through formidable support zones with an ease that is rarely seen in low volume price declines. Major support areas like 1197 and 1175 barely lasted a day, which is odd behavior.

The indices are oversold in the short term. And I would expect a bounce to the tune of 3-4 percent shortly. The real question then becomes, can the bulls regain 1197? Or will that price zone begin to act as a resistance area?