The "Flash Crash" (as it has become known) of May 6th is anything but a distant memory. It rattled traders, and it dealt a vicious blow to market sentiment. When you combine that with the seasonal factor (Sell in May, and go away) you have all the ingredients for a "sell first, and ask questions later" mentality. What seems to be a distant memory at this point is the huge 400+ DOW rally on Monday, May 10th prompted by the weekend announcement of an almost $1 trillion financial assistance package for debt-burdened European countries. The market seems determined to retrace all those gains.

While attention has been focused on Greece and the other debt-plagued southern European countries, the IMF has reminded us that the United States, Britain, and Japan are not far behind in terms of debt as a percentage of GDP. Daniel Arbess, of Perella Weinburg Partners summed it up best when he said, "The problem of the western world is we have too much debt. Rather than reducing our debt, we have been moving it from one balance sheet to another". He added, "All we are doing is shifting the chairs on the deck of the Titanic".

Debt to GDP ratios for all three (US, UK, and Japan) will go over 100% by the year 2014, according to the IMF. One economist said that by the year 2016 the United States will spend EVERY SINGLE PENNY of its TOTAL Tax Revenue just to pay the interest on the national debt. According to William Buiter, chief economist for Citigroup, "Public finances in the majority of advanced industrial countries are in a worse state today than at any time since the Industrial Revolution".

The official data doesn't tell the whole story either. Fannie Mae and Freddie Mac have been the responsibility of the U.S. government since they were placed in conservatorship in 2008. Fannie and Freddie's liabilities were $1.8 trillion at the end of last year. That represents 13% of GDP and is NOT included in the data.

If you want to get a glimpse of what the United States might be like, look at Japan. They have been in a recession since the 80's, principally because they took troubled (or failed) private assets and transferred them to the public balance sheet. Do you know anybody that has done that recently?

Warren Buffet weighed in on the currency debate over the weekend by saying that he was bearish on all currencies, for all of the aforementioned reasons. He pointed out that there are two ways that a country can solve its debt problems. The first (and most obvious) is to cut expenditures and raise taxes. The other is to print more money. Even a person that failed Economics 101 knows that the second "solution" is no solution at all because it effectively devalues the currency and causes inflation. However, Buffet points out that the United States is different than Greece (and the other European countries) in that we (the U.S.) control the printing presses and they do not (Greece, for example, can't print euro's).

And while we are on the subject of inflation, the Fed gives lip service about being dedicated to fighting inflation but privately they know that inflation is a good thing because it permits the government to repay its debt in cheaper dollars. What the Fed really fears is deflation and will take all steps necessary to combat it.

Gold has been in the news a lot lately after sprinting to a new high near 1250 about five days ago. Investors are flocking to the shiny metal as a perceived "safe haven". Traditionally, investors have thought of gold as a hedge against inflation. If government statistics are to be believed there is precious little of that (inflation) out there. In fact, the latest CPI data out of Spain suggests just the opposite (deflation). I believe the latest buying binge in gold is emotionally driven and is approaching bubble proportions. The latest COT (Commitment of Traders) report shows that retail speculators are over 96% long, whereas commercial traders (think smart money) are 60% short. I'll put my money on the big boys.


Gold Miners ETF

German Chancellor, Angela Merkel, lashed out at "speculators" and blamed these heinous miscreants for all of Europe's woes. She announced a ban on all "naked" short sales. The markets around the globe sent her a message, in no uncertain terms, about what they thought of it. What Ms. Merkel doesn't understand is that the "speculators" and short sellers are the least of her problems. The "Bond Vigilantes" are the ones she (and the rest of Europe) needs to worry about.

The term "Bond Vigilantes" was coined by Ed Yardeni (Yardeni Research) and he is referring to a handful of very large and powerful bond traders who can virtually dictate to countries what they can, and cannot do. Yardeni said, "If the fiscal and monetary authorities won't regulate the economy the bond investors will". They are the ones who decide how much a country's bonds are worth. Former Clinton advisor, James Carville, once quipped that he wanted to be reincarnated as the bond market because "they can intimidate anybody".

The oil spill saga in the Gulf continues. BP PLC said that it is recovering about 2000 barrels per day through a siphon pipe inserted into the main pipe that is leaking oil. The official estimate from BP is that 5000 barrels per day are leaking in the Gulf. However, two independent researchers (an oceanographer and a mechanical engineer) have concluded that the leak could be spilling between 25,000 BBL and 63,000 BBL per day. Tar balls, ranging in size from 3" and 8" have begun showing up in Key West. It has yet to be determined if these tar balls are from the site of the spill. If you are the government and you don't know what else to do about a problem you appoint a Commission to study the problem. That is what President Obama has done.

A new term has crept into our lexicon and that is "Strategic Default". These are individuals (or families) who intentionally default on their home mortgages and continue to meet other "meaningful" financial obligations. It has been estimated that 34% of all mortgage default are of the "strategic" variety. Many of these occur in places like California and Florida where real estate prices have dropped the most, and properties are "underwater" by as much as 25%. These homeowners know that it will take the bank one to two years to kick them out of their homes.

The Euro is trading at a four-year low to the dollar. The price this morning was just over 1.22.

Let's move on to the charts and survey some of this scorched earth and see if we can make any sense of it. SPX has suffered some serious technical damage since the "Flash Crash" on May 6th. Various levels of support (1200 and 1180) were decisively broken and will now act as resistance in future rallies. As I show on the chart below, the 20 DMA has move through and dropped below the 50 DMA (Daily). This is known as the "Death Cross" and is used by many fund managers and technicians as a sell signal. This cross occurred at the 1175 level which should offer significant resistance going forward.


Death Cross

Now that we have identified where rallies might stop, let's see where SPX might see some areas of support. The first logical support area would be at 1100. This is where the 200 DMA is located. This index has not traded below its 200 DMA since July, 2009. A drop below would be another "sell" signal to many fund managers that watch this closely. Coincidentally, this represents a 10% decline from the April high. Below that is the "gap fill" area at 1080 from February 15th. Of course, the February low of 1044 might offer some support if we get that low. And finally, we have a 50% retracement of the entire 14-month rally from March, 2009, which is at 942. I think it is safe to assume that if we get below that number SPX might head straight for the March (2009) low of 660.


Support Levels

The small caps (RUT) and the techs (NDX) have led the rally from March, 2009. If we have, indeed, had a trend change I would expect these two to lead us going down. First, let's have a look at RUT. I would anticipate that the downtrend line on the chart below at 710 would pose some serious resistance in a rally. I would also expect the swing low of 650 to offer some support as well.


RUT

The high-beta tech stocks were the favorites of the momentum investor during the big bull run, but they are getting kicked under the bus (along with everything else). NDX started 2010 at 1860 and after reaching a high of 2060 scarcely three weeks ago it is almost back where it started. I would anticipate that the swing low at 1835 would offer some support and the downtrend line at 1942 would pose substantial resistance.


NDX

While I am encouraged by economic reports that point to an improving economy, and corporate earnings that are better than anticipated, I am dreadfully afraid that the fiscal and monetary policies being pursued by the United States (and most of the rest of the western world) is going to lead to chaos and financial ruin. Societal acrimony has already begun to rear its ugly head, and I predict that it is going to get much worse before it gets better. It is already manifesting itself at the ballot box as angry voters toss out incumbents on their ear. It would be unwise, in my opinion, to flippantly dismiss the "Tea Party" people as simply some crazy right-wing zealots. I get the sense that there is a growing unrest, if not unmitigated rage, among many "mainstream" Americans. President Obama can poke fun of Arizonians about their Immigration Law if he want to, but he does so at his peril because several polls show that over 70% of Americans applaud Arizona for doing what the U.S. government is either unwilling or unable to do with a federal law that has been on the books for years.

What does this have to do with the stock market? It has everything to do with the stock market. Markets don't just respond to fundamentals (earnings, economic reports, etc.); they reflect people's moods as well. If people feel good - they buy. If people feel bad and/or angry - they sell. While I shall stop short of predicting the beginning of a Kondratieff Winter, I don't mind confessing that my mood is rather gloomy and filled with trepidation.