It's been a while since I've dedicated a daily report to stocks so today I would like to spend some time discussing the Dow. Stocks have been riding the Fed's implicit promise for more quantitative easing higher, and it now appears to me that the wave is about to wash up on shore and expire.

The initial effects of easing mean more liquidity while the long term effects mean more debt heaped on top of older obligations that will never be repaid. A once great nation is now reduced to borrowing money in order to service the interest on existing arrears with no intention of paying it back. The liquidity is a result of the printing press as the Fed becomes the buyer of last resort in both the stock and bond market. A good analogy is a patient on life support just before he takes his last breath.


Yesterday we saw the cash Dow close higher by 81 points at 11,143 and that was a new closing high for this leg up and just 62 points short of the April 26th closing high of 11,205 and 103 points shy of the all important 11,246 Fibonacci resistance. What went unnoticed by most if not all is that the Transports closed up 19 points at 4,713 but failed to make a higher closing high. The Transports closed at 4,731 on October 13th so we now have a non-confirmation of the Dow's higher high by the Transports. The question that needs to be asked is whether or not this is a significant event.


Today the Dow is trading down 100 points at 11,042 at 12:30 pm EST and the decline is being blamed on China's raising of their interest rate by ΒΌ of 1%. I don't buy that! The banks have been coming out with poorer than expected balance sheets and still they've completely ignored the foreclosure debacle brewing in the US. I think the market is now going to begin the discounting process related to the foreclosure mess and that will not be a happy time. I want you to look


at this chart of the Philadelphia Banking Index and tell me why the recipients of all that TARP money look so terrible, and as a group they have not participated in the recent rally in stocks. I have pointed this out before and I said the Dow cannot sustain a rally if the banking sector isn't participating, and it's clear that it isn't. This is the canary in the coal mine and it is telling you where the real problem resides, i.e. in the banking sector. Once the foreclosure problem hits the cold light of day, and all the big New York lawyers begin to file class action law suits, you won't be able to give these stocks away.

If the Dow has in fact topped there will be spill over into other markets over the short run. Many people have assumed that we have price inflation pushing the cost of certain commodities higher (corn, wheat, cotton, etc…), while at the same time experiencing deflationary pressures on both growth and income. I do not subscribe to that theory as most of you know by now. I see purely deflationary pressures in the economy. So if the Dow turns down here you'll see commodities prices fall and fall hard. Gold and silver will also fall back as investors scramble for liquidity. Gold could fall as low as 1,298.10 while silver could fall as low as 22.54. Maybe a little lower, but then they'll rebound and move higher to test strong resistance at 1,447.50. Likewise the dollar could rally for two or three days, maybe even as long as nine days, but nothing will save it over the long run. If the Dow has topped it means a slightly lower high and I don't think it will take all that long to give back the recent gains. The next couple of days will be very interesting to say the least.

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October 19, 2010