10/4/2011 8:59:38 AM

The Troika discovers Greek austerity falls short of goals.

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Daily Trading Action

The major index ETFs opened fractionally lower then moved higher in the first fifteen minutes then reversed to move lower than the open price in anticipation of the economic reports. Upon the release of those reports, the markets moved up fiercely into positive territory up fractionally on the day before collapsing after about fifteen minutes. From that point, it was a move lower until a rally attempt move the markets higher in the final hour of the morning. Noon marked the beginning of the end, however, as markets began a slide that would intensify as the session wore on. Rally attempts continued occasionally but always failed with a rally attempt in the final half hour failing dramatically with the last ten minutes of the session selling of hard on heavy volume to see the major indexes close at their lows down 2.4% to 2.9% on the day. This left the S&P-500 closing at a new 52-week low with the Dow only one third of one percent above its 52-week low. The NASDAQ-100 is a bit more than two percent above its respective 52-week low. All equity indexes are now in downtrend states. The Dow Jones Transport Index (IYT 72.40 -2.84) lost -3.8%. The Russell-2000 (IWM 60.99 -3.31) fell -5.1%. The semiconductor Index (SOX 326.37 -12.45) fell -3.7%. The Regional Bank Index (KRE 18.57 -0.74) fell -3.8% and the Bank Index (KBE 16.73 -0.81) fell -4.6%. The Finance Sector ETF (XLF 11.28 -0.53) fell -4.5%. All equity indexes we monitor have a bearish bias with the exception of the Semiconductor Index and the NASDAQ-100. The Semiconductor Index has a neutral bias but looks set to tip into a negative bias as early as Tuesday. In contrast, the long term bonds (TLT 123.81 +3.01) rose another 2.5% reaching a level not seen since the height of the financial crisis. It is in an uptrend state. The BIAS of longer term bonds is BULLISH.

There were two economic reports released:

• ISM Index (Sep) rose to 51.6 versus an expected 50.5
• Construction Spending (Aug) rose by 1.4% versus an expected -0.5% fall

Both reports were released a half an hour after the open. Both surprised to the upside and instilled a fierce rally that eventually collapsed.

The potential of a Greek default continues to increase. Greece and the Troika have decided that Greece won't run out of money in mid-October but instead can wait for the next round of funding until mid-November. European ministers are also looking at the next round of funding to determine the level of participation in that from the private sector. Presumably this is code for how much Greek bond holders will have to pay into the Greek bailout or, more likely, how much they must reduce Greek debt by. We suspect the level of debt forgiveness much reach the 50% level to be viable.

The U.S. dollar rose nearly another one percent to close at its highest level since mid-February. If it gets any higher it will match levels seen in January and we are only a handful of percent away from 2010 levels.

All ten economic sectors in the S&P-500 moved lower. From least to worst, the defensive sectors lost the least with Consumer Staples -1.5%, Telecom -1.8%, and Utilities -2.3% losing less than the other sectors. Tech -2.3%, Materials -2.6%, Consumer Discretionary -2.9%, Industrials -3.0%, Health Care -3.2%, Energy -3.3%, and Financials -4.5% led the losses.

The yield for the 10-year note fell thirteen basis points to close at 1.79. The price of the near term futures contract for a barrel of crude oil fell -$1.59 to close at $77.61.

Implied volatility for the S&P-500 (VIX 45.45 +2.49) rose nearly six percent and is approaching the level reached on August 8th. With the break down through the trading levels in August, it is a wonder implied volatility isn't even higher. The implied volatility for the NASDAQ-100 (VXN 46.61 +1.63) gained four percent closing at its highest level since May 2010. We believe this signals a likely retest of the year's low and a potential break of that low. That is a move of more than two percent.

Market internals were negative with decliners leading advancers 7:1 on the NYSE and by 10:1 on the NASDAQ. Down volume led up volume 9:1 on the NYSE and by more than 10:1 on the NASDAQ. The index put/call ratio rose +0.04 to close at 1.63. The equity put/call ratio rose +0.05 to close at 0.85.

Commentary:

Monday saw an early morning rally drawing in more bulls before the ambush was fully in place. Heavy volume selling then dominated trading and there was no where to hide as the major indexes closed down most of three percent. As we have been focusing on, the uncertainty over how the Greek tragedy (yes, pun intended) will play out has caused a mild panic. The Troika (European Commission, International Monetary Fund, and European Central Bank) took a look at Greece's efforts to meet the criteria for another round of funding and found that Greece hadn't met the criteria. Now, the uncertainty is whether/how the Troika can award Greece the bailout funds even though Greece hasn't met the criteria. This is like reading Hans Christian Anderson's "The Emperors New Clothes." Apparently, all government and pseudo government officials will fawn all over Greece but it will take a child to point out that Greece is naked. We will eventually get a Greek default. The nature of the default may be disguised as a debt forgiveness but Greece will default. If the default is orderly, it is possible that the contagion effect may be muted. If not, we are likely to see the world plunge into recession.

China has taken steps to mute its real estate bubble. Rather than property values continue to rise, China's central planners are reigning in credit to developers with the intent to cause the weakest of them to fail and have them consolidate with stronger developers. Fewer developers means it is easier to control the market.

We continue to believe that U.S. equities markets will have to retest this years lows at a minimum. For the S&P-500, this actually happened on Monday and we closed at a new 52-week low. The Dow is poised about one third of one percent above its 52-week low and we feel it will break down on Tuesday joining the S&P-500 in headlong flight downward. The NASDAQ-100 is currently a bit more than two percent above its 52-week low and we think it is the test of this low that will determine whether U.S. markets will continue to move lower. Reiterating what we wrote yesterday about the NASDAQ-100, "A break of the low would ensure bearish sentiment would emerge and likely confirm a new bear market. Stay tuned."

We hope you have enjoyed this edition of the McMillan portfolio. You may send comments to mark@stockbarometer.com.