IS THE FED ABOUT TO MAKE THE MISTAKE OF THE DECADE?

Just as I expected, when the market failed to rally on the debt ceiling resolution, panic set in. As I have been telling people the stock market is not dropping because politicians are debating whether or not to spend more money. They have a long record of raising the debt ceiling whenever it threatened to interfere with their spending spree. So the resolution to the debt ceiling was never in question. We knew from day one that Washington would add another trillion or so to the deficit without any real attempt to cut spending. The market has been in trouble since May because it is starting to price in the next recession.

The S&P has now breached the March intermediate cycle low. In a mature bull market that is almost always a signal that a new cyclical bear market has begun.

I've been warning investors since late April that this was coming. Many were fooled by the phony manufactured rally at the end of June. I knew at the time that the Fed's pitiful attempt to manufacture a momentum move as QE2 came to an end would fail.

All that being said, the market is now moving into the timing band for a major intermediate cycle bottom. My best guess is that the reversal today will probably trigger a weak bounce up to the 200 day moving average, followed by one more leg down. That should mark a more lasting bottom and trigger a 6 to 8 week bear market rally. That rally is going to look very convincing and I'll tell you why in just a second. But just like the rally in June it is going to fail.

Folks, a recession is unavoidable at this point. The piper is going to have to be paid for printing trillions of dollars and bailing out the financial system. Unfortunately there's no way around that. The question is will Bernanke make the ultimate blunder and initiate QE3? I'll explain in a second.

Next we need to take a look at the dollar chart. It's not a pretty picture. With the market in free fall the dollar should be rallying violently. If May marked the three year cycle low like I originally thought then the dollar should be rising rapidly by now.The fact that it's not is a very ominous sign.

I'm starting to worry that Bernanke is going to initiate QE3 and he's going to add a currency crisis on top of the economy sliding back into recession.The combination of both of these at the same time will trigger a collapse much worse than what we went through in 2008.

If the market decides that QE3 is in the cards that would be the trigger for our bear market rally. Unfortunately it would also be the trigger for another spike in commodity prices at the very time that the consumer is least able to withstand them.

What Washington and the Fed don't seem to realize is that the problem isn't the size of the dose, it's that we are using the wrong medicine. We've already spent trillions to save the economy and it failed. Let's pray that the powers that be have enough sense to recognize that more trillions are not going to cure the problem, they are going to exacerbate it.

Unfortunately what no one wants to admit is that there is no cure for our problem. We can't stop it. It can't be "fixed". All we can do is make it worse. We desperately need to face reality and initiate the painful policies that are required to halt the car before it drives off the cliff. Failure to do that will mean that the market will force reality upon us as a major global economic collapse.

Before this is all over and done I fully expect the Keynesian economic model will get tossed into the trash heap where it belongs. If it wasn't for politicians desire to spend more than they can afford Keynesian policies would have been discarded decades ago.

Portfolio change activated

PORTFOLIO CHANGE

A possible portfolio change has been posted to the website .

INTERVIEW

Here is the link to an interview with Tekoa Da Silva of ContraryInvestorsCafe.com.

Stocks Struggle To Muster A Bounce

The stocks market is struggling to muster even a bounce after yesterday's sharp selloff. Some asked why the market sold off so hard yesterday, given we had a deal on the debt ceiling. As I have said for some time, the debt ceiling was more of a sideshow, and the real underlying concern for global investors was the deteriorating conditions in Europe and the economic slowdown here in the U.S.

This morning, the ADP Employment report showed private payrolls grew more than expected in July, adding 114,000 jobs. This sparked a bit of enthusiasm and the markets staged a small bounce into positive territory. But after the ISM Services Index came out below expectations at 52.7 (down from 53.3 last month), the market began to selloff.

News that bond yields were rising in Italy exacerbated the selling. Investors are worried about the spreading contagion in Europe. It's one thing to bailout a small country like Greece, but if the debt problems spread to Italy and Spain investors worry that the ECB and IMF don't have enough reserves to bailout everyone.

Investors are fleeing into Treasuries, which has pushed yields on the 10-year down to 2.57%. Also, gold prices have hit new highs near $1671. Don't forget that oil prices are now down near $92, and lower oil prices will help out consumers if this continues.

As for the VIX, it is currently -4% lower, and has yet to surpass Friday's high of 26 this week.

Trading comment: I showed this chart below the other day. As you can see, the break of the 200-day average opened the door for more selling. But if you squint to look at the RSI index in the top window of the chart, you can see that we are now more oversold than we have been all year. So the setup for a short-term bounce is in place. If you have been thinking about lightening up, I would wait for an upcoming bounce to sell into. That's how we are playing it, as we wait for a more solid buy signal down the road.

TIME FOR A MUCH DESERVED REST

Let's face it, gold bulls have had it pretty easy the last 2 1/2 years. During that time QE1 and QE2 drove a gigantic rally out of the 2008 eight year cycle low.

Folks, at some point a move like that has to enter a lengthy consolidation.

With quantitative easing coming to an end (and QE3 not politically feasible at the moment), the economy likely rolling over into recession, and the dollar possibly setting up for a powerful rally out of the three year cycle low, I think the next deflationary period is now upon us.

 
The last two deflationary episodes forced a severe (2008) and a moderate (2010) correction in gold.

I do think demand is strong enough in the gold market that gold should hold most of its gains. However, I suspect it's going to be a lot harder to make money during the next year and a half as I expect that gold will be locked in a volatile trading range as it consolidates that gargantuan rally.

Monday Morning Musings

Well, that wasn't a very fun way to start off the week. Over the weekend leaders of the House and Senate reached an agreement on the debt ceiling to avoid default, and last night the futures on the Dow were up over 150 points. But the enthusiasm was short-lived this morning, as the market opened higher but quickly began to give back its early gains.

It appears that traders were prepared to sell into the opening pop. The Dow was up over 100 points, and then the economic news came out in the form of a disappointing ISM Index for July. The ISM fell to 50.9, well below expectations and also below last month's reading of 55.3. The news was disappointing and increased the selling pressure.

Asian markets had been higher overnight, and Europe was higher this morning. The dollar was also trading higher.

We have also seen reversals in oil and gold. Oil prices were positive this morning, but have slipped back to $95.20. And gold prices started off lower, but have firmed up near $1631.

The 10-year yield is falling further to 2.74% currently, as the bond market still seems more concerned with an economic slowdown than the debt ceiling shenanigans. The VIX is down -2.5% from Friday's spike higher.

Trading comment: The S&P 500 seems to be caught right now between its two key moving averages. Below you can see that it rallied right up to its overhead 50-day average near 1307, before running into resistance. It has now fallen all the way back to its rising 200-day moving average near 1285. This 200-day moving average is key support, and traders will lean on the SPX further if it can't hold that 1285 level.

That's the short-term picture. Right now there is also pressure coming from Europe, where the CDS market is trading near record highs for many Western European countries. Hopefully, we don't have another crisis over there like Greece. Big picture, I am still leaning towards a second half rally in the U.S. and want to buy this dip. If the market can't make new recovery highs later this year, that would be the first sign to me that this bull market may be long in the tooth.