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S&P 1030. Now what - 980, 880 or 1060?

|Includes: AIQUF, EME, HON, JCI, PH, WESCO International, Inc. (WCC), WFC
Ok, what do all these numbers mean? When the market ignores fundamentals – pointing to an improvement in the economy – look to technicals for a clue of the drop. Today’s decline of 2.6% was a big drop, so I did a simple trend line analysis. A couple of support levels were broken and one held. The question is, what’s next?
 The March low was around 680 (666 on 3/6/9 at 3:30 to be precise). The July low was at 880, the August low at 980, and the September high at 1080. This makes it easy to compute the 50% retracement levels. From the March low to the September high, 50% = 880. Strange, we hit this support in July. From the July low to the September high, 50% = 980. Hum, strange, we hit this support in August. And now, from the August low to the September high, 50% = 1030. We hit it today, closing at 1029.85. Will this be the new support?
 If it is, it’s pretty weak. Today’s move broke two more important levels: the trend line from the July to the August low, at 1050, and the line which is one standard deviation from the regression line from the July low, at 1036. This is taking place while complacency has been on the rise, and while Industrials are leading the down move. In addition, while Financials were hanging there, I did not like the September double top in Wells Fargo – which finally broke today, down a big 5.6%. I single this one out because it is kind of a leader, the other big ones being more “story” stocks – BAC, C, and even JPM.
 Why does the weakness in Industrials bother me? One, they all have forex exposure – the weakness in the dollar should help, not hinder. Two, they are the ones with the earnings leverage – indeed, this is where I made most of my Q2 performance. Three, while the jury is now out on all Q3 earnings, I do not see many other sectors with potential good surprises – it’s not going to be Housing, Consumer Discretionary or non, Autos (adjusted for the one time cash-for-clunckers). It could be Financials, who keep gouging whomever with huge interest spreads – but then, why the double top in WFC?
 Now, Technicals are one thing, but Fundamentals ultimately prevail. Here is what I think may be happening. As I said in my note of 9/23:
 The crux of the debate is are we in a rally in a bear market, or are we in the early stage of a bull market? Quite frankly, I do not know. So much damage has been done to Household Net Worth that I can’t help but think we still are in a Bear Market – with the Credit Card Debt issue being the straw that breaks the camel’s back. At this point, I would not touch any bank or alike. I still like Industrials, but they too spiked. I loved September, and I am now watching.”
 The key words are “Credit Card Debt issue”. I don’t want to extrapolate the tea leaves, but this may have something to do with WFC Chairman Dick Kovacevich’s decision to retire, confirmed on 9/22, and BAC CEO Ken Lewis’ same, announced today. What I know is that there must be a reason why banks are holding so much excess reserves - $760Bn, roughly the same as the increase in the Monetary Base since September 2008 (which was a doubling). Check the series EXCRESNS on the site of the St.Louis Fed. So much for “we are lending”.
 To put things in prospective, Consumer Credit is $2.6 trillion and Mortgage Debt $10.4 trillion. We know about the later. Re the former, in August, the major banks said their default rate ranged from 8.5% (AXP, JPM) to more than 12% (C, BAC). That was then. Assume we get to 15% on average – this equates to $390Bn. Here we go – this will mop up half of the banking system excess reserves. Add to this a bit more mortgage write-offs, we’re done. The banking system may still be in an excess reserve position, but by a Weight Watcher’s Dream margin.
 What does this do to the economy? It’s stuck, unless the Fed embarks on another wave of Money Creation. This, by the way, may explain the reappointment of Chairman Bernanke. Who else is going to take the heat for increasing the Fed’s balance sheet any further? The same guy who in November 2002 said “Deflation stops here”. To quote his speech, as I did on page 113 of my book:
 Indeed, under a fiat (that is, paper) money system, a government […] should always be able to generate nominal spending and inflation, even when the short-term nominal rate is at zero. […] The US government has a technology, called a printing press […] that allows it to produce as many US dollars as it wishes at essentially no cost”. So there.
However, we must go from point A to point B. To come back to the Market, it seems to me we are at point A – look out for these write-downs. They may happen in Q3, or maybe in Q4. I do not know, and the Invisible Hand will guide us once more. If the Market fails to hold the 1030 support, it may happen sooner rather than later. If the Market bounces from here, I do not think the upside is worth taking the risk.
On the other hand – we always seem to have more hands than the normal human body - as usual the question is liquidity. Plenty of excess reserves out there, and plenty of cash on the sidelines. We could have a repeat of Q2, when earnings were saluted by the ensuing Q3 rally. This would be for traders only, as the big difference is the now prevailing complacency. The net of it, I am anywhere from 30% cash to Market Neutral. Barring an immediate bounce above 1060, led by Industrials, the next support levels on the S&P are 1020, 1000, 980 and 880. Some stocks to watch: WCC, EME, PH, JCI, ARG, HON, WFC.

For disclosure purposes, I am long WCC, EME and JCI, and short WFC.

Instablog courtesy of Capital Max (r) and The Other Street (r).