This has been a stunning move, barely escaping the nine consecutive down days not seen since 1978. What amazed everyone was the way the selling drove the indexes through 200 day moving averages like a hot knife through butter. Usually you see a battle fought between bulls and bears around these levels that can last days or weeks. In (SPX)'s case, this happened at 1284. The McClellan oscillator became more oversold than it was at the March, 2009 lows.

The day was saved by a mishmash of data on the jobs front that was just positive enough to cause the selling to abate and permit a 28 point rally in the (SPX). Virtually all the buying was short covering.

The Challenger Report showed job cuts up 60% to 66,414, continuing 16 months of continuous rises. The pharmaceuticals shed the most workers (13,493), followed by retail (11,245), and government (9,389). The greatest losses were in the East. Cisco announced enormous cuts, followed by Merck, and Borders went out of business completely. But ADP private sector employment in July was up 114,000, with 56,000 job gains in small business.

The great mystery in all this is the volatility index (VIX). With a 120 point drop in nine days, you would expect it to rocket well into the $40's. Instead it struggled to top $25 and is now falling. This means that few are buying insurance for further downside moves. There are two possible explanations. The market bottomed today after a good capitulation sell off, sending (VIX) traders into profit taking mode. Or, the big down move is ahead of us, like the next 90 points down to 1160, and the insurance has yet to be bought. I'll let you know which one it is when I figure it out.

One thing I know for sure. Great fortunes are not made selling markets down eight days in a row. We may get the answer when the big enchilada- the July nonfarm payroll figure- comes out on Friday. The consensus now is for a gain of 90,000. Any better than that and the market could surprise to the upside.

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1) What the Markets Are Telling Us. I spent the morning doing a round robin with hedge fund trader friends of mine trying to figure how we all got this so horribly wrong. I did this as the (SPX) was ticking down to 1249 and bond yields cratered to a one year lows at 2.62%.

The uproar of the debt debacle distracted us from what was really driving the markets, the economy. While listening to the hostage drama, where the Tea Party threatened to put a bullet in the head of the world economy unless it got its way, the economic data began a rapid deterioration.

Q2 GDP was marked down to 1.3%, with an even worse revision for Q1 down to 0.9%. This is not a development friendly to asset prices anywhere, and delivered us a huge 'RISK OFF' trade.

Everyone to a man was positioned for a relief rally on the passage of the debt compromise. That's why when the rally came, up to 1,307, it lasted only 15 minutes. When too many crowd one side of the canoe, it flips over. This is why we are all swimming in red ink. Usually, I am watching this happening to other traders, not myself.

Instead of focusing on the postponement of a downgrade of US Treasury bonds, the markets instead are discounting the chopping of US growth by a third for the next decade that the congressional compromise assures. This is why bonds have soared by six points in a week. Good thing I covered my short call position on the (TLT) on July 22.

What the bond market is telling us is even more interesting. It is proof that the government is borrowing too little money, not too much. The Chinese are kicking themselves that they didn't buy 100% of our monthly bond issuance, instead of only the 50% they did, as prices are now rocketing to 30 year highs. This makes arguments that foreign investors will boycott American debt seem ridiculous. I challenge anyone to point to a market anywhere in the world that disagrees with this obvious conclusion.

The technical damage in the market is compelling, with the S&P 500 trading well below its 200 day moving average. US stocks are about to give up their year. What remains is to see whether the March low can hold here at 1249. If it doesn't, then look out below.

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Too Many Traders Got Into the Same Canoe

1) GDP is Another Bucket of Cold Water. Another bucket of cold water was thrown on financial markets on Friday with the shocking release of Q2 GDP of 1.3%. The whisper number prior to the release was at 1.9%, and even this figure is far short of the Federal Reserve's GDP forecast for 2011 of 3.0%.

Keep in mind that these are backward looking numbers giving us data that is three months old. Some of the drag was caused by a Japanese tsunami slowed car industry, which the Ford earnings this week are telling us is already starting to snap back. That's why we had a sudden drop in weekly jobless claims this week be 28,000 to 398,000, the lowest since April 2, and the most important coincident indicator there.

I have been trading my own book all year based on a much more modest 2.0%-2.5% growth estimate, and it has served me well. I believed that most economists were vastly underestimating two crucial factors. State and local spending would continue to be a huge fiscal drag as local authorities enforce emergency measures the staunch bleeding deficits.

Remember, for every $3 the federal government shovels into the economy, the states are taking out $1. And now the feds are going to stop pouring money into the economy. I also thought that there would be no bounce back in real estate in a deleveraging world, a major component of past recoveries. This makes a hash of sell side predictions of economic growth this year that ranged as high as 4%.

Billions of dollars is being spent to make you believe that the slowing economy is the result of excessive regulation, burdensome taxes, excessive budget deficits, and 'uncertainty.'? The truth is that the drag is being caused by deleveraging, gun shy bankers afraid to lend, paranoid corporations nervous about hiring, the retirement of 80 million baby boomers, and the disappearance of a consuming idle class. Multinationals sitting on cash mountains are investing it in China and India, not here. These are all long term structural drivers that no one can do anything about.

My long term scenario assumes that financial markets peak sometimes next year, about six months before we go into the next recession. Then the next crash ensues. If these GDP figures continue to deteriorate, I may have to move those targets forward.

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Coming Sooner Than Expected?

Featured Trades: (WHAT THE TEA PARTY DOESN'T KNOW ABOUT THE BOND MARKET)

 

3) What the Tea Party Doesn't Know About the Bond Market. I have spoken to several Tea Party leaders since the movement sprung up a year ago, and have come to several conclusions. This is a genuine, grass roots movement composed of people who are unhappy about the changes that have swept the country for the last 30 years. By and large, these are simple, decent, hardworking and retired people.

Their list of complaints is long, and include the downhill slide of public education, declining standards of living, falling wages for working people, the ballooning immigrant population, and the huge losses they suffered to their retirement savings and the value of their homes in the 2008 crash. They all want their lives to return to the simplicity of decades past. To a man, they want lower taxes and for the government to get out of their lives. I sympathize with them on many of their complaints.

They are also not financially sophisticated. They have no understanding of the global financial system and its many intricate moving parts. They distrust Wall Street and bankers, having been conned or victimized in the past. This is a big problem.

It is safe to say that the Tea Party leadership could care less about what happens in the bond market. The scary thing is that they think this market is something that can be simply turned on and off again like a light switch. They do not realize that:

1) US Treasury bonds are the lynchpin of the global financial system.
2) Once you break confidence in this instrument, you won't be able to put it back together again.
3) The pricing of all debt securities and loans around the world key off of US Treasury bonds.
4) Tamper with the pricing of your benchmark instrument, and the entire global financial system goes haywire.
5) The unintended consequences are uncountable.
6) Interest rates will rise across the board. LIBOR rates have already started to creep up.
7) Since many financial institutions meet their capital requirements with Treasury bonds, any undermining of their credit worthiness forces a capital call which could trigger a secondary banking crisis.
8) Short term money markets will freeze up, starving corporate borrowers of cash. This has already started to happen.
9) Mess with Treasuries, and the value of your home is toast, if it is not already.
10) Dump 'full faith and credit' and you undermine the reserve status of the dollar, one of the greatest free lunches for America of all time.

The bottom line here is that you have a bunch of kids playing with matches in a fireworks factory. It is reminiscent of the first failed TARP vote in congress, when the same group of ideologically driven republicans ignored their party leadership and torpedoed their own president's bill.

You may recall that the Dow fell 700 points that day. I do. You may also remember that the following backlash at the polls set their party back a generation. I do. Wait until they have to explain on the campaign trail that their supporter's' IRA's dropped by half again because of a principal.

If this were any other country, the center of the democratic and republican parties would break off from their radical wings, create new parties, and then form a coalition government. But we are stuck with our 220 year old form of government, so that is not an option. But the final solution to the debt ceiling crisis may resemble something like this, subject to the confines of our own, arthritic political confines.

By the way, I want to thank the many readers who have been forwarding my letters to the White House, Senator Harry Reid's office, and John Boehner's staff. I have heard from all three. Keep up the pressure.

I am hoping for the best this weekend. But I am not holding my breath.

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Must the Government Be Destroyed in Order to Be Saved?

Keep in mind that what the republicans in the House of Representatives are trying to pull off here nothing less than a Coup '?d Etat. Their machinations are a blatant attempt to expand the power of the House while they command a majority. The debt ceiling has never before been used in this way.

They have taking a normal housekeeping matter and to turn it into a political weapon. Now that they have set the precedent, you can expect the democrats to behave just as badly next time they are in the driver's seat, making all our lives permanently miserable.

I have traded markets like this before, and there is only one way to do it. Close your eyes and stop thinking. Become a robot yourself. If the market is up big, sell it. If it is down big, buy it. It is impossible to predict how the next headline will read. Stocks are really operating independent of the though process. Try an analyze this, and it will just blow up in your face.

Using this twisted, but functional logic, the thing to do after a 50 point sell off in three days is to buy. Just write the damn ticket. If you are mercifully mostly in cash, as I am, then you have plenty of dry powder to do this with. If you don't, you're screwed.

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Oops, There Goes My Position