Traders Look to Bernanke for Heroic Policy Action Once Again This Week

As the Federal Reserve gathers in Jackson Hole, Wyoming, for its conclave this week, investors around the world are hoping (maybe praying) for Dr. Bernanke and his colleagues to, once again, ride to the rescue of global stock markets.

We’ll discuss possible outcomes, but whatever happens, it’s going to be exciting.

On My Wall Street Radar

This week’s volatility brought back memories of the not so good “good old days” of 2008 as markets struggled with dismal economic reports and the increasing likelihood of a double dip recession.

This week, stock market bulls will have to make a “last stand” from a technical point of view.

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In the chart of the S&P 500 above, it’s easy to see the volatility and significant “waterfall” decline that has taken place.

However, it’s also important to note that support at the 1120 level held this week, in spite of the steady flood of negative economic reports. Nevertheless we remain firmly below the 50 and 200 Day Moving Averages and the “death cross” pattern we discussed last week still remains in play.

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The S&P 500 chart above shows the point and figure bullish support line just below current levels and a sustained break below this level would indicate a new bear market based on point and figure methodology.

These major trend lines tend to act as “walls” and a break below current levels would be significant.

The Economic View from 35,000 Feet

The economic view remains dark and threatening as this week’s readings brought no let up to the steady stream of negative data. The Empire State Index came in at -7.7, down from -3.7 previously and widely missing the +1.5 expected reading.

More shocking yet was the Philadelphia Federal Reserve report which plunged to -30.7 from +3.2 last month which is the lowest reading in this index since March, 2009, at the bottom of the “last recession.”

This is a most troubling number as readings below -20 in this index have always preceded or been accompanied by recession.

Treasury yields responded to the stock market volatility as bonds rose and yields declined to less than 2%, their lowest since the 1950s, while consumer prices continued their climb. So with rising inflation and falling bond yields, the 10 year Treasury is now producing a negative rate of return. Certainly not a good time for people on fixed income or trying to live off their bond yields.

The jobless picture remained glum with 408,000 new unemployment claims, again rising above the all important 400,000 level, while previous home sales declined to from last month’s levels, again missing a widely expected gain.

Meanwhile, gold continued its meteoric rise, prompting many to question if commodities are in a bubble.  My friends at iShares address this all important question in a very informative video, “Are Commodities in a Bubble?”

In Europe banks were pummeled with double digit declines this week as concerns about their strength mounted, and Austria and the Netherlands made the ongoing Greek bailout more problematic by demanding collateral for bailout loans.

Morgan Stanley added to the gloom by cutting their forecast for growth in the Eurozone to razor thin margins for both the rest of 2011 and 2012.

All the bad news and volatility caused the outflow from domestic stock funds to continue with the week ending August 10th seeing the biggest outflow since October, 2008.

What It All Means for Stock Market and ETF Investors

What it all means is pretty simple; more volatility, more danger and more opportunity for those who can be on the right side of these dynamic markets.

Markets remain oversold and so a dead cat bounce or bear market rally is a real possibility; however, the major trend remains negative and defensive positioning would seem appropriate.

I think that we have already entered a “double dip” recession and that we’ll see more evidence of that going forward as this global slowdown drifts into outright contraction. With U.S. growth already less than 1% for the first half of the year and economic reports continuing to deteriorate, it seems unlikely that there is any other possible outcome. At Wall Street Sector Selector, we remain defensive and expect the current downtrend to continue over the intermediate term.

The Business and Financial News Week Ahead

The big news this week comes on Friday.

Dr. Bernanke will speak at the Federal Reserve Conference in Jackson Hole, Wyoming, and market participants are hoping for a replay of last year’s conference when he laid the groundwork for “QE2.”

The second piece of news will be Friday’s revision to 2nd Quarter GDP due out at 0830 a.m. Eastern time.

Finally, August Consumer sentiment will be released and either add to or minimize the gloom. These three items will be huge movers of the market, and coming on the same day, should provide a lot of fireworks going into an otherwise quiet August weekend.

So will the cavalry once more ride to the rescue?

I believe that Dr. Bernanke will hint at the possibility of changing the duration and possibly even the size of the Fed’s balance sheet at their September meeting. He can’t make policy changes during this speech but he can hint at coming events and likely policy changes at the Fed’s September meeting, and this is a likely outcome based on recent economic reports, in other words, “Jackson Hole 2: The Cavalry Rides to the Rescue”

Significant Upcoming Economic Reports and Activity Monday:

Tuesday: July New Home Sales

Wednesday: July Durable Goods

Thursday: Initial Unemployment Claims, Continuing Claims

Friday: 2nd Quarter GDP Revision, August Consumer Sentiment, Dr. Bernanke speech
ETF Spotlight

Leaders: (NYSE:IAU) Gold (NYSE:TLH) Bonds

Laggards: (NYSE:EWG)  Germany (NYSE:EWI) Italy

Disclosure: No positions in ETFs or stocks discussed in this article.

John Nyaradi is the author of Super Sectors: How To Outsmart the Markets Using Sector Rotation and ETFs

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