Investor sentiment suffered a blow last week with the disappointing jobs data. At least for those investors who were still trading. Volume has been abysmally low once the second quarter ended. That wasn't a surprise. Everyone expected most market participants to take off early after a mentally exhausting second quarter.

The big event was the Labor Department's non-farm payrolls data. Analysts' estimates for were job losses to come in around 355,000 to 363,000 for the month of June. The real number was 467,000 with unemployment ticking higher from 9.4% to 9.5%. The unemployment number would have been worse but we have the nasty little secret that thousands of workers are falling off the list because their unemployment benefits are running out. The "real" unemployment number in the U.S. is closer to 16.5%.

Non-farm payrolls data:

Rising Unemployment:

(source: Labor Department)

Should we be surprised that the jobs number was bad and that unemployment is rising? No, not really. I've been reporting for months that unemployment is expected to rise past 10% in early 2010. That the economic recovery would be a jobless one. Businesses will be slow to start hiring workers because the pace of recovery will be lower than expected. With unemployment hitting 26-year highs and poised to keep rising for the next six to nine months we're going to have a consumer confidence problem. Of course you already know that because we've been talking about it for weeks. I've been harping on the vicious cycle of rising unemployment, rising foreclosures, falling home values, falling consumer confidence, a rising savings rate, a consumer-led economy, and how they all feed on each other.

So was the reaction to the jobs number "real"? With most money managers on holiday and extremely light volume should we trust the sell-off on Thursday? The rising unemployment number isn't new news on Wall Street. I suspect that traders may have been hoping for an improving jobless report and the light volume only exacerbated some minor disappointment.

Technically the S&P 500 still has a bullish trend of higher lows but boy that trend is getting harder and harder to see. What concerns me is the bearish head-and-shoulders pattern. If the S&P 500 breaks support near 880 the H&S pattern is forecasting a drop toward the 810-800 zone, which is pretty much inline with a 50% retracement of the March-June rally. The market would probably find support near 850 for a little while but broken support at 880 would act as new resistance. Once 880 breaks we'll have bears screaming that the market will retest the lows and that this was all just a bear-market rally. Is this what we have to look forward to? Maybe. It depends on earnings.

Chart of the S&P 500 index:

The second quarter earnings season is about to begin. Dow-component Alcoa (AA) kicks off the season on Wednesday, July 8th but the reports really don't start flowing until the following week. Investors are tired of news that is "less bad" and want to see some improvement. If earnings results disappoint then management better have some positive things to say about the second half or the market could easily sell off and a descent toward 800 would be a good bet.

We have a number of oil and energy stocks on the LEAPStrader newsletter so I want to discuss oil for a moment. The action in crude oil over the last couple of weeks is bearish. Oil acts like it's forming a top. There is a lot of conflicting news in the oil sector with renewed violence and outages in Nigeria to the oil inventory numbers to reports concerning a slow down in demand. Underneath it all is the U.S.dollar/oil undercurrent. The dollar is expected to continue its trend lower, which is bullish for oil and other commodities traded in dollars. Yet this commodity-dollar relationship hasn't worked lately with commodities selling-off sharply. This sector could end up seeing another sharp correction if earnings news disappointments.

Chart of the OIX Oil index:

I mentioned it in the play updates section and I'm going to repeat myself here. The next couple of months could be painful for the bulls. The third quarter begins one of the worst periods of the year for the NASDAQ and we're already in the worst six months of the year for stocks in general. Investors will want to consider how they can protect or hedge their positions if the market does correct. However, I want to remind you that there is still a lot of money on the sidelines. The big picture is that an economic recovery is coming the question is how soon. Money managers will buy the dip we just need to be watching for when they do. Is that the 850 level or is that the 800 level? The current H&S pattern says it will be near the latter.

As LEAPS traders we want to be ready and waiting if this correction appears. The market isn't going to drop to 800 in a week. It will take a while to occur so we need to be patient when it comes to launching new positions. A third quarter correction would set up for a traditional fourth-quarter rally. We can use this time to search for new opportunities so send me your investment ideas as we look past earnings season.

~ James Brown