Employment Fear Sparks Breakdown – Look For Continuation!

The market has a distinctly negative tone to it this week as traders return from holiday. Monday, the market spiked higher after hurricane Gustav produced less damage than expected. After an initial rally, the market reversed the rest of the day and ended on a weak note. Energy prices lead a massive sell off in commodities. Prices did not spike ahead of the hurricane and I do not believe that the "near miss" can be blamed for the decline. I have heard comments about demand destruction. This situation would take months to unfold and I do not believe it was the cause for the decline. This commodity plunge feels like panic selling. I suspect that traders and investors were over exposed to this sector and they are bailing out/liquidating. In the next few weeks, we are likely to hear of a hedge fund failure or two. This drop will set up a capitulation low and this sector will present a buying opportunity once it has established support. The fundamentals for energy are still intact and global demand continues to grow. Supplies are slow to come online and there are many potential disruptions that lie ahead. Two new hurricanes are making their way toward the US and one of them is already a category four. Russia continues to occupy Georgia and they can toy with the oil supply that feeds Europe. Instability in Iran, Venezuela and Nigeria could also disrupt supplies. I am long-term bullish on energy. In the short term, lower commodity prices will help the Fed maintain its current interest rate policy. Bond prices imply that we will not see a rate hike this year. This week, Australia lowered its interest rates. The BOE and ECB have been more accommodative as well. This has helped to strengthen the dollar and it is another reason that commodity prices have fallen. The FOMC does not meet for two weeks and their rhetoric won't be a driving market force. Next week, the economic releases are very light. The most significant number is the PPI and it won't be released until Friday. As long as commodity prices continue to drift lower, even a "hot" number will be discounted. Retail sales will also be released on Friday and we will see if lower gasoline prices are sparking sales. Today, higher gasoline and food prices were blamed for sluggish back-to-school sales. The key driver over the next few weeks will likely come tomorrow. The Unemployment Report will tell us which way the economy is heading. Yesterday, Challenger, Gray & Christmas reported a 29% increase in layoffs during the first eight months of 2008 compared to the first eight months of 2007. Initial jobless claims increased by 15,000 last week and the continuing claims rose to a concerning 3.44 million. After the last four Unemployment Reports, the market has declined. Can you tell which way I’m leaning? If the unemployment rate rises, the credit crisis will spread beyond sub-prime loans. We are in a seasonally weak period and I believe the market will breach support at SPY 126 as it retests the lows from July. We are trading down substantially today and much of the bad news might be factored in by the end of the day. From a trading standpoint, a breakdown would be a relief. We have been chopping back and forth in a tight trading range for the last six weeks. The movement has been random and we need momentum. Regional banks and retailers have bounced recently and they both present shorting opportunities if the unemployment number rises.

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