Market Summary

NASDAQ Market Signal Reverts to 'exit'

Friday's large sell-off brought up another distribution day for the NASDAQ and our market model again signaled an 'exit'. This was the fourth reversal in June alone and is indicative of the nervousness that pervades the markets. For the week the DJI lost 2.05%, the S&P 500 slipped 1.98% and the NASDAQ Composite gave up 1.44%.

The markets were roiled on Friday by fears that the full effect of the subprime lending debacle has so far been hidden from investors and that when the full extent is known there will be a "blood bath" among one or more hedge funds to rival the collapse of Long Term Capital Management which failed in 1998 with a loss of $4.6 billion. It is believed that certain hedge funds are carrying mortgage backed securities on their books at unrealistic levels and that if they were 'marked to market' the funds would be insolvent. The extent of this could be revealed in auctions that Merrill Lynch is holding of $800 million Bear Sterns mortgage backed assets. More details here. Of greater concern is the risk to the larger financial community. Bloomberg reports that the SEC is concerned about the 'systemic risk' that could result: U.S. Securities and Exchange Commission Chairman Christopher Cox said yesterday that the agency's division of market regulation is tracking the turmoil at the Bear Stearns fund. ``Our concerns are with any potential systemic fallout,'' Cox said in an interview. …

We can expect that if such a catastrophe occurs a rescue operation will be organized as was the case with the LTCM collapse and that financial institutions will survive!

The short term effects on the markets could be disastrous though while the storm is being weathered but we can also expect the Plunge Protection Team to step in at some point.

In the short term, it will be best to be in cash until the storm passes.

The effects on the consumer and the larger economy are likely to be severe. Mortgage rates are rising rapidly and home loan applications are consequently falling which will further depress the struggling housing market. Quoting Bloomberg once again:

“Rising Rate Pushes Housing, the Economy to a Blood Bath

The worst is yet to come for the U.S. housing market. The jump in 30-year mortgage rates by more than a half a percentage point to 6.74 percent in the past five weeks is putting a crimp on borrowers with the best credit just as a crackdown in subprime lending standards limits the pool of qualified buyers. The national median home price is poised for its first annual decline since the Great Depression, and the supply of unsold homes is at a record 4.2 million, the National Association of Realtors reported.

``It's a blood bath,'' said Mark Kiesel, executive vice president of Newport Beach, California-based Pacific Investment Management Co., the manager of $668 billion in bond funds. ``We're talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit.'' Confidence among U.S. homebuilders fell in June to the lowest since February 1991, according to the National Association of Home Builders/Wells Fargo index released this week. Housing starts declined in May for the first time in four months, the Commerce Department reported yesterday. New-home sales will decline 33 percent from 2005's peak to the end of this year, according to the Realtors' group, exceeding the 25 percent three-year drop in 1991 that helped spark a recession.

The S&P 500 closed below its 50 day moving average on Friday and is showing a possible head and shoulders pattern. The H & S is a bearish pattern when confirmed, which occurs when the price drops through the neckline at about 1460. Note that it has rallied twice since forming the right shoulder at 1538.71 and failed to beat that level, indicating that the pattern may well be confirmed eventually.

On a brighter note, with fewer breakouts occurring this week (just 7 compared to the recent average of 20), our subscribers were automatically reigning in their pace of new investments. The average breakout rose 1.9% by week's end, however, showing a positive return while the indexes were drowning.

There were no new features added this week.

Go to Cash Until the Bear Stearns Situation is Resolved

Markets are likely to be volatile until the extent of the subprime CDO (Collateralized Debt Obligations) debacle is known. Also, there are several economic indicators released next week that will affect the markets (existing home sales on Monday, new Home Sales on Tuesday, Durable Goods Orders on Wednesday and GDP on Thursday) and the FOMC meets on Wednesday with a press release to follow on Thursday at 2:15 pm.

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