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We switched to "Red Flag Flying" mode, expecting lower prices ahead.

Mid week we entered inverse positions in both the standard and leveraged portfolios and have unrealized gains/losses ranging from -0.8% to +5.3%.

Our new Sector Selector 2X is up +5.3% in unrealized gains and the Standard Portfolio gained 1% this week. 

We switched to Red Flag because our macro scoring system flashed a "sell" signal last week.  There are several components to this but some include a Point and Figure "sell" signal on the Dow Jones Industrials, a bearish signal on the S&P 500, and a Point and Figure "sell" signal on the Wilshire 5000, our total market index.

We will try to take advantage of the correction by using inverse ETFs but a more conservative approach would be to tighten stops, lighten exposure to long positions or buy protective puts.

There is no way to know how long or how deep this correction might go but it is the most significant set of signals I've seen since the start of the rally in March.

However, earnings season is just getting underway and surprises could come to the upside which would force us to reverse course, as well.

The View from 35,000 Feet

Markets weakened considerably this week as a flurry of economic reports cast doubt on the strength and sustainability of the recovery.  The jobs report on Friday came in substantially worse than expected with unemployment now at 9.8% and another 263,000 jobs lost for the month. 

Unemployment now stands at a 26 year high and many analysts actually put the rate at double the published rate when you add in discouraged workers who have given up looking and part timers who really want full time work.

The scary numbers are that we've had 21 consecutive months of job losses, and 7 million jobs disappearing since December, 2007.  The work week is at a record low 33 hours and the companion household survey mentioned a much worse rate of employment attrition.  When the stimulus bill was enacted, it was supposed to keep unemployment below 8% and so that mark was missed by a wide margin.

CIT, the big lender to small businesses, appears to be back on the ropes with a possible bancruptcy filing by year end and Bernanke said this week that the recovery won't be strong enough to drive down unemployment in 2010.  He also says that the commercial real estate situation we've discussed here on numerous occasions is a "very serious problem" but shouldn't cause another financial crisis.  Of course, he had a similar view at the outset of the sub prime crisis.

Three more banks were seized on  Friday, bringing the yearly total to 98, and the Chicago PMI contracted unexpectedly this week along with the Institute for Supply Management report which dropped for the first time this year.

The S&P currently trades at 19X earnings, it's highest level since 2004.

Car sales were down -30% or better last month as the cash for clunkers program wore off.

And "Dr. Doom," Nouriel Roubini, was quoted by Bloomberg as saying in an interview in Istanbul that "stocks have risen too much, too soon, too fast."

And finally, investors have ignored the fireworks in the equity markets this year as they've poured more than ten times as much money into bond funds as equity funds year to date.

The Week Ahead: 

The data was mostly bad last week but the S&P managed to hold key resistance at 1021, its 50 Day Moving Average.  It came down to test that level and then bounced to close for a small loss at 1025.

A break through 1025 would be extremely bearish while 1040 is now new upside resistance.

Earnings season starts on Wednesday with Alcoa and so this will be another huge week for global markets.  It's a light week for economic reports but everyone will be looking for signs of better profits an especially top line revenue improvements.  The market has risen on the notion of a "V" shaped recovery, and if it's going to be something other than that, it could get very ugly, very quickly.

Monday: September ISM Services Report 

Wednesday: August Consumer Credit 

Thursday: Weekly Jobless Claims, August Wholesale Inventories

Friday: August Trade Balance 

Sector Spotlight:

Leaders: Inverse ETFs 

 
Laggards: South Korea, Homebuilders, Real Estate

We will have to remain nimble in this crazy market.  I'm looking forward to if and when we find ourselves in more peaceful days ahead.

We took our annual fall camping trip to South Twin Lake.  It's a favorite spot and a bittersweet time of year as summer comes to an end, but the campground is always deserted except for a few hunters.  We had a wonderful evening and hike around the lake and got home in the nick of time because today it snowed about four inches at our house. 

It looks like an early winter, and I must be getting old because I used to celebrate the first snow and approaching ski season and this year feel like a trip to Hawaii would be just about right.

Wishing you a great weekend wherever you may be.  To get a Complimentary Special Report from Wall Street Sector Selector, click here:

John

John Nyaradi

Publisher

Wall Street Sector Selector

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