Last summer the big question in the markets was whether or not the European Central Bank (ECB) would print large quantities of money in an effort to cap rising bond yields in Europe. Between July 6 and August 8, 2011, the markets were not confident about getting assistance from European policymakers or the ECB. In the end, the ECB flooded the financial system with enormous amounts of printed money, but prior to making that announcement the S&P 500 dropped 17% between July 6 and August 8.

The relevant point for us today is the markets fell sharply during the period of uncertainty. You can argue the uncertainty relative to Europe in 2011 escalated as the S&P 500's 50-day moving average turned down (see red arrow in chart above), which is an indication of a weakening uptrend. Moving averages are used to filter out shorter-term volatility, allowing us to focus on the bigger picture in terms of trends.

Fast forward to the present day and we find more uncertainty related to outcomes and possible repercussions in Europe. This morning's Wall Street Journal captures the gravity, and possible short time frames, relative to this stage of the Greek tragedy:

Swedish Finance Minister Anders Borg, whose country is in the EU but not a member of the euro, warned Tuesday while attending a meeting of EU finance ministers in Brussels that Greece may be nearing the end of its time in the euro zone. "We are very close to the end of the road," Mr. Borg told reporters. "The situation is very serious."

The markets seem to understand the serious nature of the challenges facing Europe. Last week, the slope of the S&P 500's 50-day moving average turned down, indicating a shift toward risk aversion. While there is no question the market's current bias is to the downside, any good news could spark an oversold rally similar to what we saw in June 2011. Like June 2011, an oversold rally may prove to be short-lived.

Markets are always looking ahead. Given Greece most likely will hold new elections in mid-June and that by the end of June, the country must detail and approve fresh measures to close a budget gap of €11.5 billion, the markets are anticipating increasing uncertainty in the weeks ahead.

Between mid-June and the end of June, Greece must form a new government and pass controversial budget measures. All this seems like a tall order from the market's current perspective as evidenced by the recent break of the Dow's 22-week moving average (MA). All things being equal, a move below the 22-week MA is a bearish signal.

Another question facing the markets is what happens if Greece fails to make the necessary budget cuts to obtain additional aid. From Scotland's Daily Record:

If Greece refuses to make cuts, European leaders are likely to withdraw bailout funding agreed in March and an exit from the euro is almost certain. And if that happens, the impact on the UK and other European countries would be devastating.

The S&P 500 has also reacted to the heightened risks in Europe by dipping below the 22-week moving average. The markets are in the process of shifting from "risk-on" to "risk-off". A move below the 22-week can be short-lived (see early 2010 below), but it should be respected until the market provides some bullish clues.

Another major area of uncertainty is the possibility of an escalating flight by depositors from Greek banks. From today's Wall Street Journal:

The steady outflow of deposits from Greek banks hasn't yet turned into a full-blown bank run, and the European Central Bank has nearly limitless capacity to provide banks with additional liquidity. But economists have long warned that a run on banks could develop if the population fears Greece's departure from the euro is imminent and that their savings would evaporate. A bank run could trigger the euro exit if it reaches a scale that forces Greek authorities to freeze bank accounts and print their own currency to keep the financial system alive.

Like the Dow and S&P 500, tech stocks are in the process of breaching their 22-week moving average. The moves on weekly charts become more meaningful if they carry into the end of the week.

Adding to the concern about a possible full-blown run on Greek banks, is the real possibility that ECB support could disappear if Greece fails to make the necessary budget cuts by the end of June. Both the long and shorter-term trends in the euro reflect the real possibility of membership changes in the EU. The euro has remained below its downward-sloping 200-day moving average (see red arrow below), which is often used to define a bear market. The purple arrow shows the shorter-term moving averages have recently rolled over in a bearish manner. Like stocks, the euro could experience an oversold rally on any good news from Europe, but the long-term trend remains firmly down.

The most significant area of uncertainty relates to the Greece-leaves-the-euro scenario. The Wall Street Journal touched on the topic this morning - note the use of the unfriendly-to-the-markets term 'collapsing':

If Greece leaves and investors begin to question the viability of the euro in other vulnerable countries, such as Spain and Italy, Germany and the rest of Europe could be forced to take bold action to keep the currency from collapsing.

As we noted on May 10, gold appears to be questioning the ability of central bankers to ward off deflation. As of Tuesday's close, gold's 200-day moving average continued to roll over in a bearish manner. The chart below also shows the shorter-term moving averages (green, red, and blue thin lines) crossing below the 200-day MA, which is also negative relative to trends in the yellow metal.

We outlined in an October 2011 video the magnitude of the problems related to a global economy saddled with too much debt. In today's world, the markets have become a battleground for deflationary and inflationary forces. The deflationary forces are writedowns and defaults. The inflationary forces come from central bankers desperately trying to keep asset prices artificially boosted in an effort to "buy time".

You can make an argument that the best way to monitor the inflation/deflation battle is to look at commodity prices. Commodities are used to hedge against the unlimited amounts of paper/electronic money that can be created by the ECB and Fed. Commodities are also in greater demand when the global economy is growing. As shown in the chart below, commodities reacted to the eye-popping injection of cash from the ECB in late 2011. However, the sugar high from the ECB could not carry commodities over the bull/bear demarcation line (the 200-day). The failure of the CRB Index to clear its 200-day moving average in late February was the first clue the deflationary forces had not been extinguished by the ECB's printing press.

Traders, with much shorter time horizons than investors, create "tradable" oversold bounces. A trader-induced rally could come at anytime, but even that is not guaranteed given the news of the day. The S&P 500 dropped 17% in summer 2011 with little in the way of resistance from traders.

Our risk model, which tracks the health of the markets using numerous sources, has dropped firmly into neutral territory. Until it shows some meaningful improvement (more than an oversold bounce), we will continue to take cues from our defensive coordinator. If the head-and-shoulders pattern turns out to be the market's guide in the coming days, longer-term investors should pay closer attention if the S&P 500 trades between 1,280 and 1,306.