The following commentary was posted at Gillespie Research

Summary

For a while now, I've been docketing this summer -- July in particular -- for some serious trouble in the US stock market. The month's first two trading days got off to an inauspicious start for the bulls. Although the current week is a holiday shortened, four-day affair, it should still provide a more substantive idea of whether last Thursday and Friday's declines were precursors to worse things on the horizon. I suspect they were, and my definition of "worse" entails double-digit losses for the bellwether measures during this month.

Last Friday, around 11:00 AM (ET), I put out an update relating specifically to Friday's market behavior. I don't usually get into such short-term trenches, but I think what was happening on Friday was important, especially for the purported reasons.

From that missive:

"Two days a quarter do not make! But weak bond and stock closes today could signal that something indeed is in the process of change, and not for the better, either.

"...Today's immediate reactions to the weaker-than-expected employment numbers were a sell-off in stocks and a sharp rally in bonds ... I suspect it was the right reaction [in stocks] but probably for the wrong reasons. As to the bond market, I suspect it was simply the wrong reaction, although there are some strong technical forces that contributed to the initial rally.

"There's still plenty of time left in the trading day for stocks to rally, so I'm not going to draw any conclusions about July commencing with two back-to-back down days. But were today's close to be a weak, negative one, it very well might be signaling an important change in direction.

"...What I suspect may be just ahead of the debt and equity markets is not only getting a stronger whiff of stagflation, but also beginning to react to it ... If stagflation is the direction in which we are heading, as I believe it is, it surely is not be bullish for either market."

The Near-Term Backdrop

I intend to publish a detailed midyear review/outlook soon, examining the economic and financial-market prospects for the next several months as I see them. I'll briefly state here that the backdrop I will opine in that piece will be one of an economy generating increasing disappointments vis a vis the wildly optimistic forecasts of early this year, disappointment accompanied by growing inflationary pressures and rising interest rates. In short, the climate I envision will not be great for stocks.

In addition, I believe Iraq in the post-handoff period will be "problematic," and I also believe we are entering a period in which the potential of terrorist acts against Americans -- including here in the United States -- will be heightened.

Yes, yes ... I know the countervailing argument. Alan Greenspan will not let anything bad happen to the economy and the markets because he is master of the universe. Well, it just could be that before this year is over, Greenspan will wish he had not taken the fifth term as Fed chairman, and that Bush will wish he had not offered it.

And speaking of the President, there's a very decent chance that after John Kerry has his pick of a running mate in place (rumor has it the choice will be announced today and it will be Dick Gebhardt), and after the Democrat nominating convention has come and gone, Kerry will take a major move up in the various polls, although one that might well atrophy later in the summer. A post-convention spike would be consistent with historical patterns, and the phenomenon might represent another depressant for stock prices during July.

Some Parameters

The first two trading days of July saw an average decline in my seven-measure stock-market tracking group of 1.7%. All seven components fell, with losses running in a range of 0.9% for the NYSE Composite, to 3.4% for the NASDAQ 100.

As of last Friday, the tracking group stood, on average, 3.8% below respective 2004 highs. In this regard, declines ran in a range of 2.8% for the S&P 500 and the Wilshire 5000, to 5.7% for the NASDAQ 100.

As the above table indicates, two components' highs are now three months old, with the rest of them even older. A while ago, I opined that there was a good and growing chance these highs would be the highs for all of 2004. If July pans out as I expect, it would certainly enhance the prospect that the major bellwether highs for this year are already in place.

Also a while back, I predicted an approaching market down-leg that would test or even slightly violate respective 200-day moving averages. This objective was fulfilled during May. I believe tests/violations of respective 200-day moving averages are again on the agenda, but this time around, the breaches could be a good deal more severe than in May.

The following table projects a range of levels for the DJIA, the S&P 500 and the NASDAQ Composite from last Friday's close. The maximum violation projected in the table is 10%, which would produce overall declines somewhat larger. And yes, I believe July has the potential to be that bad.

Two-week rate of change is a technical series I've found to be useful at certain junctures. The recent pattern for the Dow and the S&P give the appearance these proxies already have rolled over, and that the NDX is doing so. This is another factor lending support to a near-term price decline of some significance.