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Monday Morning Quarterback: Five Battles Will Define the War

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Dynamics that will shape the year-end tape.

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It's a slinky summer Monday as a holiday stretch looms large.

The action is decidedly seasonal and market players have embraced the relative calm after almost two full years of stomach churning swings.

You remember American Home Mortgage, right? As that meaningful minnow swam offshore in the summer of 2007, Minyanville offered, "The potential for deeper downside dislocation is higher than most individual investors have factored in."

That begs the natural question, have we seen this movie before? As volatility measures shrink faster than a shy violet and volume levels taper off (remember, bulls want to see broadening participation on higher volume), we're left to wonder if history will again rhyme if not outright repeat.

The financial markets are an amalgamation of a confluence of variables, which is why trading-and investing, for that matter-is more art than science. Ask ten people what any particular element "means" and you'll likely get ten different answers.

Ten-year Treasury yields rising from under 3% to near 4%? Hoofy will point to increased risk appetites and narrowing corporate credit spreads while Boo sees a viable asset class alternative and it could portend further foreign debt sales.

The jump in equity issuance? Hoofy will argue that the wheels of capitalism are again in motion while Boo seethes that the government manufactured a rally so corporate -and banks in particular-could transfer watered down paper to shareholders.

The abyss vs. the miss? With the S&P trading in a svelte 9% range since the beginning of May, the bulls believe we're "basing" (above S&P 875) while the bears buzz of a "churn" (below S&P 950).

Inflation vs. Deflation? While the massive expansion of the Fed's balance sheet and money supply point to the former, consumer balance sheets (which account for 65% of GDP) are contracting at a more pronounced clip.

Value is in the eyes of the beholder? With "Armageddon" in the rear-view mirror, bears will offer that the forward-looking P/E was 11.7x at the March lows, higher than the 10.5x P/E at the 1990 nadir or the 9.8 P/E following the 1987 crash. For good measure, they'll note that the current P/E is very close to the October 2007 market high.

The reality of the situation, as summarized in the 'Ville through this period is as follows. The government effectively bought the cancer and sold the car crash, which is to say they kick-saved an apocalyptic systemic collapse but inhaled more toxic waste than John Coffey on Green Mile.

Now, following a massive rally that shifted psychology from the fear of losing to the fear of missing (and risk management to reward chasing), the simple truth is we're back to the levels when Warren Buffett told everyone to buy equities in the Op-Ed section of the New York Times.

One Foot in Front of the Other

We've been discussing a stair-step approach to the market, using technical levels as a contextual framework as we edge through these slinky summer sessions. Through that lens, three levels stand out: S&P 900ish (the 50- and 200-day moving average), S&P 920ish (the near-term toggle) and S&P 950 (the most important level of the year).

After fading (making sales) at S&P 950 a few weeks ago and covering that exposure at S&P 920, I made fresh sales when we broke S&P 920 last week as past support is future resistance. Discipline dictated covering that exposure when we popped (through my stop) to the upside Friday morning but I called an audible and doubled down on my negative bet.

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No positions in stocks mentioned.
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