The Morning After

 | Sep 22, 2011 | 8:45 AM EDT
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"Try to relax and enjoy the crisis." --Ashleigh Brilliant

If the Fed can't save this market, what will?

Although it wasn't at all surprising, yesterday's announcement of Operation Twist produced a strong negative market reaction. Some market players were hoping that the Fed would expand its balance sheet rather than just adjust maturities, and the statement that there are "significant downside risks to the economic outlook" didn't help matters.

What's most troubling isn't what the Fed did or didn't do, but the market's reaction. This is the first time since the low in March 2009 that a Fed action has been greeted with so much pessimism. The market has consistently reacted in celebratory fashion to just about everything Fed chief Ben Bernanke has done and said, so it is very worrisome that the market is losing faith and acting as if the Fed is out of ways to bolster this economy.

Unfortunately, without the Fed to act as a support, we have to look at the news flow and the fundamentals -- and that sure isn't going to entice many buyers. Maybe the contrarians who believe that things are so gloomy that they can't get much worse might be interested in catching some falling knifes, but the average investor is going to have a tough time finding reasons to be a buyer. The economic news and the crisis in Europe are downright frightening, and there is no quick resolution in sight.

If we forget the fact that the news flow is absolutely terrible and just look at the technical picture, it doesn't provide much confidence. Since the market's sharp early August drop, we have been in a wide trading range between 1120 and 1225 on the S&P 500. There have been three attempts to break to the upside on "Greece Is Saved!" news that no one really believes anyway.

We have held above the 1120 level, but we are going to come close to testing it this morning. As I've stated, I'm very concerned that if we test that level again it won't hold. The general rule is that the more a level is tested, the more likely it will not hold. I don't think the market is going to bottom out until we make a new low for the year and produce another washout.

I don't see any reason to play the bottom-calling game. If you aren't already short, the best place to be is in cash. The fundamental situation right now looks as bleak as it has been since the 2008-2009 crisis, and the lesson of that period was not to underestimate how much we can drop.

Think defense.

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