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Careful What You Ask For


The sell-offs may satisfy sellers and attract bottom-fishers, but the bounces have only refueled the decline.


The third consecutive Friday sell-off got a lot of attention over the weekend. More attention should have been given the two consecutive Monday bounces that have trapped buyers. The sell-offs may satisfy sellers and attract bottom-fishers, but the bounces have only refueled the decline. Eventually the trend of lower highs and lower lows does reverse up, but sometimes not before one of those sell-offs attracts a newer, more dangerous breed of sellers, while bottom-fishers realize the futility of their efforts.

Now another bounce is underway, and this one is ahead of schedule, with S&Ps trading sharply higher several hours before the cash session open. It would appear that disaster has been avoided again. The event of a crash is such an outlier as to never make it likely. But the market can be vulnerable in varying degrees to the possibility, and this pattern is among the most possible. Now an overnight bounce has refueled sellers once again.

Q: When is a pullback not a pullback?
A: When it's an anvil.

S&Ps opened last week after a week-long drop from July's new high. The drop was steep and it was deep and it was nothing new in the world of pullbacks - not if that's all there was to it.

But to label July's high as being a "new high" is misleading. July 12's break above June's prior high improved a little more the following day, and the following week not so much. MACD & RSI quickly began diverging negatively, and then began the slide. Long before S&Ps had fallen under July's prior lows, July's "new high" had proved itself a false breakout, a false breakout from a seven-week trading range.

Reversals from false breakouts aren't pullbacks. The second sizeable single-session drop off of July's highs was confirmation that something much bigger was underway, and now June and May's lows have also been broken. Last week's multiple sizeable single-session drops don't suggest much has changed.

This Time, It's Personal

Most of this weekend's talking heads didn't suggest much had changed, either, and stuck with the tradition of comparing the decline to prior percentage losses. We are reminded that the Dow and NDX are still ahead by double-digits for the year. Finally, from no less than Ben Stein comes this panacea that the decline's culprit - sub-prime loans - comprises a tiny fraction of the debt markets, which is only a single element of stock market valuation.

Of course, size isn't everything, and structure is more so. Regardless of the percentage drop in absolute or relative terms, its most damning feature is that it originated from a seven-week trading range's brief false breakout. The Dow and NDX double-digit gains still leave plenty of market froth to fall flat in-line with the broader S&Ps that have been leading the decline. And the sub-prime market's measurements notwithstanding (remember, size isn't everything), the same can be said of the proverbial butterfly that flapped its wings over the South Pacific.

The more things change...

Speaking of the Dow and NDX still sporting double-digit gains this year, that outperformance held up in another way last week. While S&Ps dropped to new lows Friday, the Dow and NDX did not. The relative performances are capable of producing a bounce, but not a sustainable recovery - not until the Dow and NDX are underperforming the broader-based S&Ps.
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