Getting Ready for the Big One

Markets were literally all over the map on Wednesday, up in the early going after shrugging off the ADP September Private Sector Employment figures - a loss of 254,000 jobs, worse than expected - and getting a bit of a boost from the final, revised 2nd quarter GDP report of -0.7% until the Chicago Purchasing Manager's Report for September came in at 46.1, far weaker than the expected 52.0, sent stocks into a dizzying tailspin.

The bottom was reached early in the day - 9608 on the Dow, a drop of 134 points - and the markets staged a spirited rally until finally regaining all of the losses and going positive at 1:00 pm. The highs for the day were attained shortly thereafter, and stocks gyrated to a negative close, though much better than early indications.

Dow 9,712.28, -29.92 (0.31%)
NASDAQ 2,122.42, -1.62 (0.08%)
S&P 500 1,057.07, -3.54 (0.33%)
NYSE Composite 6,910.88, -15.94 (0.23%)

Despite moderation into the close, the markets appear to be setting up for a massive sell-off prior to earnings season. A spate of negative economic news cannot be ignored much longer, nor can the fact that stocks are up over 50% from their March bottoms. A correction is overdue considering all the variables involved and it could be quite large and not easily countered.

The last two major sell-offs (see chart here) were whoppers. On August 17, and again on September 1, the Dow dropped 186 points in each instance. In each case, the big drops followed days in which stocks had fallen and recovered off their lows, such as today.

If history is to be our guide, a drop of 200 points should be in the cards. Today's lows were severe, and the recovery unjustified, aided only by weakness in the US dollar, which does not account for individual stock gains, nor is that kind of pricing model sustainable nor realistic. Markets, at some point, have got to go back to fundamentals, and they are sorely lacking in almost every sector. Earnings have been good the past two quarters due to deft cost-cutting and downsizing. It is about time for the markets to grow up, with investors looking for top-line growth on increased sales and profit margins.

Unfortunately, as we head into 3rd quarter earnings season, most companies have not exhibited the kind of performances that would denote sustained growth from increased sales and volume. This really could be the end of the line for the nearly 7-month old rally, one of the best ever. It is difficult to believe that any money manager would be holding strong positive positions heading into Friday's Non-farm payroll report, much less hold long positions before tomorrow morning's Initial claims (8:30 am) and ISM index (10:00 am) readings. Judging by the direction of recent reports, both could be worse than expected, and the non-farms payroll number could be the ultimate market killer, so, instead of one, neat, massive decline, stocks may be in for a double dip, which could derail the rally and finally decouple stocks from oil and the dollar.

Extreme caution is urged.

On the day, the simple indicators were pointing toward more carnage. Decliners beat advancing issues handily, 3817-2644, and new highs bested new lows, though by a declining margin, 330-50. It should also be noted that new lows should be very subdued due to the ravages of the past year.

Significantly, volume was at the highest level in nearly two weeks.

NYSE Volume 7,226,821,000
NASDAQ Volume 2,543,707,250

Commodity traders made the most of the weakened dollar, as oil gained an outlandish $3.90 per barrel, to close at $70.61. Gold popped $14.90, to $1,009.30, while silver gained 48 cents per ounce, to $16.66.

With more data concerning employment and the economy dead ahead, the indications are for a strong influence of data on stocks, much of which has been negative, or, at best, an aberration in the general upward slope.

The remainder of this week and the early part of next appear to be full of pitfalls for short-term investors.