Global economic fears and worries over a European bank meltdown forced a major market drop at the open and the lack of an early rebound forced billions of dollars in margin selling ahead of the close.

Market Statistics

Many investors bought the dip over the last week and probably a lot of that buying was done on margin. Others holding on to positions bleeding dollars more than likely lightened up on non-essential holdings to keep the margin police away. Today that all came crashing down as sharp change in outlook in Europe caused a meltdown in overseas markets. That decline carried over into the U.S. markets with a -200 point Dow open to 11,700. Traders tried to buy that dip at the Wednesday lows only to see the slide continue. By late morning the pressure really began to build to raise cash for margin calls. Those who bought the previous declines also began to reevaluate their declining positions and then the margin police began to show up in force.

The post lunch decline was voluntary margin selling but the closing drop was clearly forced sales to bring traders back into compliance before trading ended. There was a lot of money lost today and the markets suffered some serious technical damage.

Futures positions were especially hard hit because they produce instant cash when sold. Traders nursing positions in crude oil, copper, etc, were forced to blow out their positions to raise cash. Even gold and silver futures where profits were still growing at the open and assets you would expect to do well in a global economic meltdown were crushed as well. Gold set a new high this morning at $1685 before the liquidity crunch forced traders to dump positions and it fell back to close at $1650.

When rough times appear you go for the birthday money setting on the dresser, empty all your old suit pockets, check under the cushions for lose change and check your recent receipts to see if there is anything you can return to the store for credit. If all else fails you dig out the hammer and head for the piggy bank. That is your bank of last resort. There is a Wall Street saying, "When you can't sell what you want to sell you sell what you can."

Today futures positions in gold, silver, copper, oil were the equivalent of the last resort to keep from breaking into the piggy bank of margined equities traders really wanted to keep. By the time the smoke cleared with the Dow down -513 points the margin police had liquidated over $600 billion in market value today alone. That is the dollar equivalent to a 60 point loss on the S&P. In the last ten days the U.S. market has lost -$1.4 trillion in market value. With that kind of loss in that short of a time period there is no place to hide. Investors were forced to even dump some of their favorite positions just to raise cash and satisfy the margin police. It was not a pretty day.

There was also a rumor that margins on gold and silver were about to be raised again like we saw during the last bubble in April. Traders did not wait to see if the rumors were correct. Also, if you are getting margin calls because of the drop in crude futures then the easiest way to solve that is by selling profitable futures positions in things like Gold. That does not mean oil and gold are not worth what they were yesterday it just means traders needed cash.

Gold Chart

WTI Crude Futures

Brent Crude Futures

Helping push commodities and equities lower was a +1.63% spike in the dollar to a three-week high. This is a massive move for a single day when movement is normally tracked in tenths of a point. Any commodity denominated in dollars was crushed. The dollar was soaring because of a sudden deterioration in Europe and currency actions by several countries. Switzerland cut rates and said it would flood the market with supply to make the Swiss Franc less desirable in order to stem the flow of money into the country. Turkey took similar steps. Japan sold the yen and pledged to inject 10 trillion yen ($126 billion) into the market do stem currency gains. Japan also said it would expand its current asset purchase program to 50 trillion yen ($630 billion).

Sparking the Thursday decline was a sudden worsening of the outlook for Europe. The EU Commission President Jose Manuel Durao Barroso sent a letter to all country leaders saying in part, "Developments in the sovereign bond markets of Italy, Spain, and other Eurozone member states are a cause of deep concern. Though these developments are clearly unwarranted, they reflect a growing skepticism about the systemic capacity of the euro area to respond to the evolving crisis," Mr. Barroso wrote. "Whatever the factors behind the lack of success, it is clear that we are no longer managing a crisis just in the euro-area periphery." The ECB left rates unchanged at 1.5% and offered "cheap and unlimited credit" to Eurozone banks to increase liquidity. The Bank of England also left rates unchanged. Both the ECB and BOE had been talking up rate hikes until just recently. This sudden turn of events and speculation they will actually cut rates soon suggests the European economy is grinding to a halt. New worries are beginning to surface that France and Belgium may need help. Credit default swaps on France surged to new multiyear highs today. Even credit default swaps on Germany rose to two-year highs.

The ECB hinted it would begin buying bonds to shore up banks and countries but did not specifically say if it would buy bonds from Spain and Italy, the countries in the most trouble today. However, Spain was successful in selling 3.3 billion euros of short-term bonds today with twice as many bids as bonds offered but the rate was close to 6%.

There are persistent rumors of Europeans in general quietly withdrawing all their money from banks in the form of cash. There is a general fear that the crisis will eventually turn deadly and the banking system or at least quite a few banks will not survive. If this stealth run on the banks continues it will eventually cause the demise of that banking system. This is causing some serious concern on the part of analysts.

The drop in the Euro and serious spike in the dollar was very detrimental to our markets.

Dollar Index Chart

Euro Chart

In the U.S. a very strange thing happened today. Because of the sudden race to increase liquidity banks are suddenly awash in cash. Bank of New York Mellon (BK) sent a note to clients saying it would begin CHARGING 0.13% interest on cash on deposit at the bank. That is only for balances over $50 million per client relationship. If you have multiple accounts the total of all would be the determining factor. The fee begins next week. The bank cited heavy dollar deposits over the last month as the factor. By charging a fee they are offsetting their expenses for handling, tracking and managing the influx of cash. By charging a fee it forces large accounts like money funds and other financial institutions to put the money elsewhere.

The cost of bank borrowing in the overnight markets went to zero on Thursday after starting the day around 0.08%. Banks, funds, investment houses, corporate treasurers and others have pulled their money out of risk assets and moved it to banks like BNYM, JP Morgan and other custodial banks because they are insured by the FDIC. Custodial banks are typical safe havens in times of market stress. In the late 1970s Switzerland imposed a charge on deposits to halt the rise of the Swiss Franc that was driving up the price of Swiss products on the world market.

Banks have to pay 0.10% to the FDIC as deposit insurance on the cash they are holding. Typically these balances also earn a minor amount if interest for the depositor. As cash balances swell the amount of interest the bank would pay plus the FDIC deposit insurance could turn into a loss for the bank thus the new 0.13% charge. Normally banks would be thrilled with an influx of new deposits but the lack of loan demand today means they can't put the money to work.

Money funds and equity funds are raising cash in anticipation of withdrawals by investors abandoning the market given the increased volatility. Yields on treasuries plunged with the yield on the two-year hitting a record low. Yields on shorter term notes are near zero with the one month going negative for a brief time. The supply of T-bills remains tight because the Treasury Dept is restricted from issuing new ones because of a clause in the debt limit compromise. There is another prime example of unintended consequences. The yield on the two-year note went as low as 0.275% today and a new historic low. The 3-month yield is 0.008% or basically zero.

Ten Year Yield Chart

30-Year Yield Chart

On the U.S. economic front there was a very light calendar. The weekly Jobless Claims came in at 400,000 and last week's 398,000 claims were revised higher to 401,000. The blip back to a four handle was psychologically depressing but given the rest of the market's problems nobody really noticed. This is just more indications that the Nonfarm Payrolls could be ugly on Friday.

Weekly Jobless Claims

Chain Store Sales for July slowed significantly from 6.9% in June to 4.6% in July. That falls to only 3.5% if you exclude fuel. Despite the decline in growth sales still increased but the rate of growth is slowing. With the market imploding it will further depress consumers ahead of the back to school shopping season. Unemployment and summer layoffs are depressing sales. Add in the drop in the wealth effect from the falling stock market and I would expect a further decline in sales in August.

The only material economic report due out on Friday is the Nonfarm Payrolls. The consensus estimate remains a gain of 85,000 but almost nobody expects that to really happen. The odds are very good we could see a loss of jobs or only a minimal gain. There is also a chance the +18,000 gain from last month could be revised lower.

I believe an ugly jobs report is already priced into the market. However, the market is not really reacting to our economics alone. We could have a decent jobs number and not see the market rebound.

The paradigm is changing. In 2010 the market rallied on expectations for a better 2011 and the first half didn't really work out that well. In the first half of 2011 it rallied on expectations for a stronger recovery in the second half. We are already in the second half and guidance has been lousy. Growth expectations are being cut daily. JP Morgan cut their estimates to 1.5% growth for 2H from 2.5% and given the recent economics that could be overly aggressive.

Companies are guiding lower or not giving guidance at all and more than a few are being very vocal about the state of the economy and government intervention on businesses. The Emerson CEO was a prime example last week. The environment is changing and uncertainty reigns supreme. When businesses don't know what to expect in the future they retreat and become more conservative about expansion plans. That is exactly what we have seen over the last couple months.

There are credible voices starting to claim we are already in a double dip recession and it is hard to argue with them. Bert Dohmen, author of Prelude To Meltdown (2007) predicted the financial crisis. He wrote an article in Forbes on July 17th claiming the new recession had already started. He pointed out that economists in May were talking about the "soft patch" but he believes it was the start of the double dip recession. Dohmen has called the start of every recession for the last 33 years and many times to the exact month. He claims the 2008 crisis was due to the failure of companies. He believes the current crisis could involve the failure of countries. That could force a change in the "too big too fail" saying. Will it now be "too big too bail?"

Since the GDP for Q1 was revised down from +1.9% to only +0.4% growth what assurance do we have the Q2 GDP at +1.28% won't be revised down by a like amount and turn negative? This is what the market is worried about along with the meltdown in Europe.

The only bright side to the cloud of impending doom that settled over our market on Thursday was the feeling the Fed would be forced to act when they meet next Tuesday. Nobody expects a QE3 because rates are already lower now than when they were pressing QE2. There are several options they can use but unfortunately they have already used up their big bullets. If the jobs report is ugly you can bet the Fed will take action on Tuesday. We just don't know what kind of action they will take or whether it will have any impact on the market.

The U.S. markets were not the only markets in the tank today. This is a global meltdown not just America. Other declines included DAX -3.4%, CAC 40 -3.9%, FTSE 100 -3.4%, Bovespa -5.7% and TSX -3.4% to name just a few. The Dow lost -4.3%, NYSE -5.4%, Nasdaq -5.1%, S&P -4.8% and Russell -5.9% and that is just one day.

Since the close on July 21st the Dow has lost -1,343 points or -10.5%. The S&P lost -144 points or -12%. The Nasdaq lost -302 points or -10.5% and Russell 2000 -114 points and -13.5%.

In normal markets, when investors are not worried about banks or countries failing, a day like Thursday would be a capitulation day. Volume on Wednesday's rebound was a paltry 6.4 billion shares across all markets. Today volume was more than double at 13.8 billion shares. That is the highest volume I can remember since the 2008 crash. Down volume was 12.9 billion shares compared to up volume of only 826 million shares. That is 15 times down volume to up volume and would normally be a capitulation event.

Volume Table

Unfortunately I don't think Thursday was the bottom. Futures are still declining Thursday night and we can bet that European and Asian markets are going to follow us lower. If there is going to be a capitulation event I would expect it to be Friday. Unfortunately with Europe spiraling around the drain I would seriously doubt if anyone would want to go long into the weekend. Major events overseas are likely to happen on weekends.

The S&P has fallen into correction territory with a massive breakdown below the last material support level at 1250. That was the March bottom and it is well behind us now. The stop at the close at 1200 was psychological round number support and not specifically a material support level. The next real support is 1175 and a negative jobs report could easily test that level. Based purely on the chart there is nothing to suggest the drop is over.

Obviously we can bounce at any time given the oversold conditions but as long as the race to cash continues any bounce will be sold. I wrote on Tuesday I expected any rebound would be sold and Wednesday's lackluster rebound was definitely sold. This was the 14th largest single day point loss for the S&P.

S&P Chart

The Dow closed at the low for the year at 11,383 and the next material level is 11,000. Unless something changes drastically very soon we could see that level on Friday. Triple digit moves are starting to become the norm once again. IBM was the biggest loser at -7.35.

Dow Component Chart

Dow Chart

This was the biggest loss for the Nasdaq since January 2009. Techs gave back a whopping -136 points. Big losers were GOOG -24, DNDN -24, ISRG -20, AAPL -15, NFLX -16, VRUS -13, FSTR -12, DECK -11.50 and WYNN -11.

There is really nothing to say about days like this when the favorites get crushed for reasons not related to any stock fundamentals. This is purely an economic and geopolitical event and not stock related.

Nasdaq Chart

Bull markets have corrections and they don't normally come from the direction you would expect. There is always an outlier event that triggers a change in sentiment and then the rush to the exits begins.

The VIX rose +35% today to close over 31 and the highs for the year. This indicates the level of panic from investors racing to buy puts to protect existing positions. Spikes of this magnitude don't normally last but then countries don't normally fail either.

What happens when those investors with jobs get home tonight and see the market summary on TV? Do they rush into the market at the open on Friday and start buying bargains or do they utter expletives and rush to place sell orders to protect them against whatever is pushing the market lower. I guarantee you 98% of retail investors will have no clue why the market collapsed. They don't understand why institutional investors are racing to cash. This is extreme uncertainty that maybe be more dangerous than the flash crash. At least everyone thought they understood why the flash crash occurred but they still avoided the market for the next six months.

Most investors have no clue why bonds or sovereign debt have an impact on their stocks. I doubt very many even understand the problems in Europe even though they have been in the news for over a year. This is voodoo economics to them and they either sit there like a frog in pot of water numb to the rising heat or they pull the ripcord and bail to cash like everyone else. Only a very few will go bargain shopping.

The Nonfarm Payrolls tomorrow morning will be a sideshow to whatever happens in Europe overnight. While the markets are extremely oversold after the last ten days there is nothing to prevent them from becoming more oversold. You can bet there will be more margin selling in the morning as the computers sort through the carnage from today and send out the margin calls overnight.

If you must play in traffic I would suggest some short term calls on the index ETFs like the DIA, IWM, QQQ. The premiums will be cheap and a market that falls 500 points in a single day can also rebound 500 although I would seriously doubt it. I don't see the macro picture changing that much overnight.

Remember my closing comment from Tuesday, "The next week is going to be pivotal for the markets and I believe volatility will increase."

Jim Brown

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