Last Thursday, Dubai’s quasi-default on a $3.5 billion bond sent shockwaves through the global credit markets. The Dow fell 154 points, with all 30 components down. Only four stocks in the S&P 500 were green on the day. As we noted on Friday morning, however, holiday trading can be exceptionally volatile.
 
The government of Dubai stated that its state-controlled holding company, Dubai World, does not have a financial guarantee from the government and therefore its creditors must deal with the issue. To draw a parallel, this would be like Washington disowning the debt of Fannie Mae and Freddie Mac.

It does not pay to get bearish on this market. Not yet, anyway.

The Dow was down just 14 points on Friday, which set the stage for the surprise rally on Monday morning. The dollar weakened about half a percent over the weekend. Since U.S. equities are priced in dollars, the declining greenback creates buying pressure, since shares look cheaper to overseas buyers. We think this trend is likely to continue until the Dollar Index falls to its 2008 low, about 5% lower than Monday's close.

There is considerable resistance for the Dow in this area due to a cluster of Fibonacci projections and the downtrend line from the October 2007 high. This technical resistance would be expected to act like a brick wall, preventing a further advance in the Dow.
 

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All three major indices set new yearly highs on Monday, which the financial media regards as particularly bullish. One reason is that the S&P 500 has been lagging the pack. With ‘confirmation’ from the S&P, some market technicians are breathing a sigh of relief. Hummmm.

Yesterday, the Dow closed up for the 5th day in a row, but just barely. Basically, Tuesday was a consolidation day. Lately, such pauses have punctuated a series of strong advances.

News flow was also downbeat yesterday. Various Fed officials noted the weak employment picture and the increasing prospects for a jobless recovery. Dennis Lockhart, president of the Atlanta Fed, warned that non-performing commercial real estate loans will be affecting smaller banks. Consequently, these troubled banks will not be making loans to small businesses, thereby crimping the recovery. If you are a small business person you know this is already the case.

On Monday the Dow moved into the ‘speed zone’ as expected. We are looking for a rally to 10,500.

On Thursday, the market decided it preferred the upside direction. This morning, a worse than expected jobs report is depressing index futures, but we think the market will get over it and make new highs for the year shortly.

The vast majority of stocks correlate with the direction of the major indices. (+) or (-) signifies a change in status today.

Short-term Market Direction: S&P 500: Down.

The SPY tested the gap zone #3 last Wednesday at the 1040 level, then bounced strongly on Thursday, as expected. Friday it resumed the downtrend, which we also predicted, and closed below the 1040 gap. The next target is now a bit below the 200-day moving average at roughly 985 in the S&P 500.

There are three ways to willingly become a creditor of the U.S. government; buy Treasury Bills, buy Treasury Notes, or buy Treasury Bonds.  Treasury Bills, often referred to as T-Bills, are U.S. government debt issued for less than one year.  They are issued at a discount to par, so interest is paid when the principal investment is returned. Treasury Notes are government debt issued with a maturity of 1-10 years and pay interest semi-annually. Treasury Bonds, sometimes called T-Bonds, are U.S. government debt issued with a maturity date of more than 10 years.   T-Bonds also pay interest semi-annually.

During periods of extended market weakness, small caps tend to fare worse than large caps because they have less institutional sponsorship.  We can see this by comparing two ETFs, Direxion’s 3X Small Caps Bull (TNA) and Direxion’s 3X Large Cap Bull (BGU).  With the Dow down 1.21% on Wednesday, Direxion’s small cap ETF lost 9.74%, while the large cap ETF lost 6.09%.  That’s more than a 3.5 point  difference and means small caps lost about 60% more than large caps.  Volume was above average for both funds, with TNA trading 60% more shares than normal and BGU trading 25% more shares than normal.