The market was continuing merrily in its bullish ways through most of Wednesday until a respected analyst downgraded Wells Fargo to ‘sell.’ Then all hell broke loose, causing the Dow to plunge about 200 points in one hour. Although the venerable index closed down less than 100 points, the intraday swing was remarkably swift and certainly reminded traders of the adage that stocks fall much more quickly than they rise.

Wells Fargo “beat the Street,” earning $2.6 billion or 56 cents per share for the third quarter. Analysts forecast just 37 cents a share. Credit losses more than doubled to $5 billion year over year, but interest income rose 43% to $5.5 billion and non-interest income from mortgage banking more than tripled to $10.7 billion.

Richard Bove, however, questioned the sustainability of the mortgage income and the fancy hedging activity that Wells Fargo is utilizing to make its numbers, which the company will not discuss. He also noted that its non-performing assets nearly quadrupled from the same period last year and climbed 28% sequentially.

While some financials were weakening on Wednesday, Morgan Stanley was rallying, having returned to profitability for the first time in a year. Income from its investment banking operations offset losses in commercial real estate. Morgan Stanley earned $498 million in Q3 after losing $13 billion during the last three quarters. With the banks clearly making money now, we think the selling in the sector will subside today. Nevertheless, we like the Direxion bearish financial symbol FAZ for the intermediate term.

Crude oil rallied above $81 yesterday on a weakening dollar, which boosted the entire energy sector. The selling in the banks spread like wildfire, however, so the energy names were unable to sustain their intraday gains. The dollar's decline was greased by comments from a British central bank governor that hinted at higher interest rates. This news strengthened the British pound, sending the Dollar Index to a 12-month low. We don’t think the dollar has much further to fall in the short term.

Lastly, a survey of more than 100 institutional investors in 20 countries reveals that 90% expect the S&P 500 to return to 1200 by the end of 2011 and 75% believe the index will make new all time highs by the end of 2013. This means is that big money did not sell into the 2007-2009 market decline and big money is not yet selling into this rally. This ‘explains’ why the rally has been so smooth.

Institutional investors have long time horizons and the survey shows that the traditional belief in a sustained secular bull market in the West is largely intact. We don’t expect institutional selling to begin in earnest unless and until the S&P falls below the March 2009 low. That is the line in the sand. Hedge funds and institutional trading desks will move the market around in the mean time. If and when the 666 level is violated to the downside (that was the March intraday low in the S&P 500), we expect a new type of selling to come in, one that has not been seen in the West ever before.