Stocks are bouncing up and down and we continue to see investors do the safety dance out of stocks and into bonds (not to be confused with the one-hit wonder by "Men Without Hats").

Not much has changed in a week. Stocks continue to drift lower as investors worry about a slowing American economy. Traders were temporarily distracted by some merger news but overall late season corporate earnings failed to inspire and economic data continues to depress. The flight to safety continues with both U.S. and German bonds surging. The yield on the 10-year and 30-year German bonds hit 2.26% and 2.89%, respectively. The U.S. 10-year bond yield is at 2.61% and the 2-year hit an all-time low near 0.48%.

The big headlines in corporate news was M&A activity. Semiconductor giant Intel (INTC) offered to buy security software maker McAfee (MFE) for almost $8 billion. It's a move that many industry experts are skeptical of. BHP Billiton (BHP) made a $38 billion offer to buy Canada's Potash Corp. of Saskatchewan (POT) that has now turned hostile. It could be a good move for BHP since fertilizer demand is expected to grow for the next several years.

There are several issues that are putting investors on the defensive and likely to push stocks lower. First and foremost has been the near constant stream of negative economic data. Last week we got two more reasons to doubt the rebound with jobless claims rising and manufacturing starting to weaken. Economists were expecting initial jobless claims to rise on Thursday but they were not expecting a jump to 500,000. Not only is that a damaging psychological number but it's the third weekly rise in a row and doesn't bode well for the next jobs report in early September.

While the initial jobless claims data was bad the Philly Fed business activity survey was worse! The last few months have seen a parade of economic data showing the U.S. is slowing down but the manufacturing sector has been the sole standout and inspiring hope that we won't see a double dip. Unfortunately the Philly Fed numbers are suggesting the manufacturing sector is also starting to reverse. Economists were expecting a rise from 5.1 to 7.0 in the Philadelphia Federal Reserve manufacturing survey, with numbers above zero showing growth. Instead the July numbers reversed sharply falling to negative -7.7. Now one report doesn't make a trend but it certainly hurts investor confidence. We'll see more regional Fed surveys this week.

Another challenge is Greece and Europe's debt problem. I have been warning readers for weeks that the European debt crisis has not been solved and remains a problem. There have always been doubts on how Greece could repay the billions and billions of bailout funds as their economy quickly sinks into a depression. Now it seems the Greek economy is crumbling faster than expected with a tidal wave of bankruptcies and massive unemployment. Worry over Greece will quickly spread back to Spain, Italy, and Portugal. The sharp drop in the euro is a clear sign that confidence in Europe is quickly fading in spite of some better than expected GDP figures in the euro zone region.

Daily chart of the Euro ETF (FXE):

Daily chart of the U.S. Dollar ETF (UUP):

The U.S. is still facing an extremely fragile residential real estate market. I feel like I have been harping on this for over a year now so I'll keep this brief. Foreclosures are still at record highs (near one million in 2010) and they are expected to get a lot worse (+50% in 2011). It's all a vicious circle. Consumers are scared. They're saving more and spending less. Lower consumer spending means the economic rebound will be weak. Weak sales mean businesses will be cautious and slow to hire again or worse they'll reduce their headcount even more as they see the economy getting worse. High unemployment will exacerbate the foreclosure problem, dragging down home values, which scares consumers.

The only potential positive I see is the record low mortgage rates. This past week Freddie Mac (FRE) said the rate on a 30-year fixed mortgage hit a new all-time low of 4.42%. That's the lowest level since FRE started keeping track back in 1971. While everyone would love to refinance most homeowners can't qualify due to tighter, stricter lending requirements and negative home equity. However, there is a huge amount of adjustable rate mortgages that are due to reset this year and in 2011. With rates this low it's possible these mortgages could adjust lower or stay low, which would be a real boon for consumers and thus the economy.

I am also concerned about the upcoming election cycle. These elections will be nasty as several incumbents face an extremely tough fight. I realize I'm being cynical here but it seems like both sides will say anything to get elected. There will be plenty of talk about how bad the economy is and how they can fix it. All of the negative hype will have a bearish impact on consumer and investor sentiment. More and more Americans are raising their voices about the massive U.S. deficits, which will likely play a role in the election this year. Without a doubt it will be interesting to see what happens. Speaking of deficits about 90% of state governments are struggling with budget shortfalls. As they cut back on spending it will include a reduction in headcount, which only adds to the unemployment problem.

Next week we will see an increase in economic reports. A few of the highlights are the Chicago Federal Reserve business activity index on Monday. Tuesday we'll see the existing home sales figures. Wednesday will bring the Durable Goods number and New Home Sales report. Thursday is the weekly jobless claims and the Kansas Federal Reserve manufacturing survey. Friday will see the U.S. Q2 GDP revisions and the latest consumer sentiment figures. Expectations for the housing reports are falling. These could be market movers. Don't be surprised if home sales see a -5% decline, which would be really bad since summer is the height of the selling season. The biggest event is probably the next estimate on U.S. Q2 GDP. Do you remember the trade numbers from two weeks ago with the trade gap surging to $50 billion. That was a lot higher than expected and will force a downward revision in Q2 GDP. Analysts are estimating that the already disappointing +2.4% Q2 growth could get revised down to +1.5% or even +1.0%. This report could set the stage for a sharp sell-off into the Labor Day weekend.

Technically the market continues to look bearish. There are a few short-term indicators that are suggesting we might be a little oversold but any bounce is probably temporary. The S&P 500 failed twice at round-number resistance near 1100 last week. The low on Friday tagged the May 6th "flash crash" lows. I suspect we'll see the S&P 500 correct down toward the 1040 level in the next week or two and we might see the July lows near 1010 before September is out. If the S&P 500 breaks the July lows then things could get pretty ugly. The index has a bearish head-and-shoulders pattern that is forecasting a decline toward the 860 area. Personally I think the S&P 500 would see some significant support near 950.

Daily chart of the S&P 500 index:

Weekly chart of the S&P 500 index:

In summary I suspect that traders will continue to sell into rallies. Volume is going to remain very light until after the Labor Day weekend. Hopefully Wall Street's fund managers will come back from summer vacation with a positive attitude. Otherwise we could see them clean house and sell everything heading into the Q3 earnings season. I am crossing my fingers that the market will find a bottom in October and we'll be able to ride a year-end rally into Christmas. We should have a much better read on the double-dip recession risk by mid October but the market could remain volatile until after the early November elections.

~ James Brown