Traders looking for an excuse to sell ahead of the September volatility found the perfect excuse in the Syria headlines.

Market Statistics

The drumbeat is increasing over a potential U.S. attack on Syria and nations are lining up on both sides of the issue. The consensus today is that the U.S. and at least one ally could launch a cruise missile strike as early as Thursday night. The strike is expected to be punitive and brief due to the lack of allies willing to stick their necks out after the flawed intelligence over suspected Iraq WMDs in 2003. The UN cannot sanction the action because Russia has a veto on the Security Council.

The Arab League supports an attack by the U.S. and allies to prevent future use of WMDs by Assad.

British Prime Minister David Cameron recalled Parliament to hold an emergency vote on Thursday so it is highly unlikely there will be any attack before then. Some White House commentators suggested they would likely wait until Saturday and after Friday's day of prayer in order to be sympathetic to the civilian population.

With the German elections only four weeks away it is doubtful they would take part in any military action. The German foreign minister said if Syria was found to have used WMDs Germany would "support consequences." That does not mean they would participate but they would give their backing.

France has already said it will support any action.

Russia continues to protest the potential attack on their ally. They sell Syria billions in weapons plus they have an energy and petrochemical partnership.

The Russian Defense Minister warned an attack on Syria could have "catastrophic consequences for the region and called on the international community to show prudence" over the crisis. "Attempts to bypass the Security Council, once again to create groundless excuses for a military intervention in the region are fraught with new suffering in Syria and catastrophic consequences for other countries in the Middle East and Northern Africa." Deputy Prime Minister Dmitry Rogozin said "the West behaves toward the Islamic world like a monkey with a grenade." Russian officials are comparing the potential use of force against Syria to the 2003 invasion of Iraq based on flawed intelligence on weapons of mass destruction.

Russia warned the U.S. specifically there would be consequences to using force in Syria. They did not say what those consequences would be.

The Iranian Foreign Minister said Monday "We want to strongly warn against the use of force against Syria. The use of military force against Syria will incur serious consequences for the region. The consequences will not be limited to Syria but will engulf the whole region." Iranian armed forces Chief of Staff said, "If the U.S. crosses the red line and attacks Syria, there will be harsh consequences for the White House." Analysts view the multiple comments by Iran as a potential warning that Iran could insert itself into the fight. Personally I think that would be exceedingly dumb but it is Iran we are talking about. I think they believe Russia will back them up.

The markets imploded over the potential ramifications of the attack. Syria said it has aimed all its missiles at Israel and will retaliate against Israel and anyone launching missiles against Syria. The Syrian air force would likely have little success against an armada of coalition ships currently spread out across the eastern Mediterranean. Syria does have some late model air defense capability and they are thought to have some anti-ship missiles.

Syria is thought to have 178,000 active duty troops with 27,000 in the air force and 36,000 in air defense. Approximately 314,000 are in the reserves. It is hard to know today how many are left after desertions, call ups and casualties. Syria had 4,950 tanks when fighting began 30 months ago. Analysts believe they have 365 Soviet built fighter planes, down from 555 in 2009. Air defense capability has not been degraded since the rebels have no aircraft. Syria has "several thousand" ground to air missiles. Assad is protected by an additional 50,000 elite troops.

Israel said it would strike back "fiercely" if Syria attacks the Jewish state. Netanyahu said "We are not part of the civil war in Syria, but if we detect any attempt to hurt us, we will react, and react fiercely. We are prepared for any scenario." There were some comments in the press that suggested Assad might launch his WMD arsenal towards Israel at the beginning of any attack since the U.S. will be trying to destroy his WMD capability. I wonder if Assad is that stupid since a confirmed WMD attack on Israel would bring an even stronger reprisal from the U.S. and others. Israel said there had been a 300% increase in the delivery of gas masks in recent days. Every Israeli should have one.

Crude prices rocketed higher because the northern Iraq crude pipeline cuts across the corner of Syria before moving across Turkey to the sea. The pipeline carries 25% of Iraq's 2.32 mbpd of crude production. Cutting the pipeline would drive up crude prices and would be one way to get back at the U.S., the world's largest consumer of oil, for attacking Syria.

Oil production in surrounding countries could also be impacted by attacks from Syrian forces. There are worries Iran could also attempt to join the fight on the side of Syria and maybe lob a few missiles towards Saudi Arabia and Kuwait. Al Qaeda could also take advantage of the confusion to implement their "change the face of history" attack that was delayed a couple weeks ago.

The global production of crude was already seeing near record disruptions with 2.7 mbpd of the world's 89.5 mbpd in production currently offline. If we lost another 600,000 bpd from the Iraq pipeline and possible disruptions in other countries in the region we could be in real trouble.

EIA Global Oil Disruptions

Crude prices rallied to $109 in the U.S. and $115 for Brent. Those were 52-week highs on both contracts. We can expect gasoline prices to rocket higher over the next week.

WTI Crude Chart

Brent Crude Futures

The market hates uncertainty and there was plenty of it around on Tuesday. The economics on Monday were ugly with the July Durable Goods headline number falling -7.3% compared to a gain of +4.0% in June. Analysts were quick to suggest again the QE taper was slowly moving farther into the future.

Today we saw the exact opposite. The Richmond Fed Manufacturing Survey rose from a severely negative -11 in July to +14.0 in August. The Richmond Services Survey rose from -6.0 to +14.0 as well. The manufacturing survey showed a dramatic increase in the components. The new orders component rose from -15 to +16. The production component rose from -30 to +3.

While this is good news it is also questionable news. The Richmond Manufacturing Survey has been very volatile over the last two months. As good as the numbers were this month they were equally bad last month. I suspect this was more of a data timing problem than a true representation of the manufacturing economy in the Richmond region. In the case of the new orders it is illogical they would decline from +9.0 to -15.0 and then rebound to +16.0 in a 60 day period. I would be skeptical of the validity of this data. However, the data has been very volatile for the last nine months.

Richmond Fed Manufacturing Data

Richmond Manufacturing Chart

The Consumer Confidence for August rose slightly from 81.0 to 81.5 and has now been above 80 for three months. That is a post recession high. The present conditions component declined from 73.6 to 70.7. The expectations component rose slightly from 86.0 to 88.7.

With the headline heavy September period ahead I would expect the present conditions component to decline sharply for September. The last time the debt ceiling debate occurred in July 2011 the present conditions component declined to 32.5. That is the big decline on the chart in mid 2011.

The Texas Manufacturing Survey rose for the fourth consecutive month. The index rose from 15.3 to 16.7 after falling to a low of 3.7 in April. The Texas report is not really followed by the market but the positive trend is encouraging.

The Case-Shiller Home Price Indexes rose +12.1% for the three months ending in June. However, that was slightly lower than the 12.2% for the period ending in May. This was equal to the 12.1% in April. That means home prices did not really rise in Q2 and remained flat as 12.1% over Q2-2012.

Analysts were quick to increase their "housing market is slowing" warnings. They needed no encouragement after the big drop in New Home sales on Friday. This is a warning sign for the Fed when they meet in three weeks.

The economic calendar for the rest of the week is highlighted by the GDP revision and the Chicago ISM. With weakness in recent economic numbers and the concern over Syria we could see the comments from Bullard and Lacker move more towards taper off rather than a September taper announcement.

Economic Calendar

Gold and silver rallied sharply as the Armageddon trade took on new meaning with the cross currents surrounding the potential Syrian attack. Silver rallied +2% to $24.50 and very strong resistance. This is a four month high. If it moves over $24.50 there will be another round of heavy short covering.

Gold extended its gains with a +$22 sprint to $1415. That is also very strong resistance but unless peace breaks out unexpectedly I suspect we will see further gains with $1475 the next target.

The Dow declined -170 points and market reporters blamed the Syrian crisis. However, another reason for the decline was comments by Jack Lew. The Treasury Secretary was interviewed by CNBC over the coming debt ceiling battle. He reemphasized the administration claim they would not negotiate over raising the debt ceiling. He used the code words that have worked so well in the past. "The government could default on its obligations" and "Congress should act as soon as possible to protect America's good credit by extending normal borrowing authority before the risk of default becomes imminent." Also, "If investors should become unwilling to loan the U.S. money, the U.S. could face an immediate cash shortfall." These were the same sentences he used in a letter to Congress on Monday.

The U.S. Treasury has been using "special operations" for the last two months in an effort to stretch the cash until the new fiscal year begins on October 1st. They are currently expecting to run out of money by Oct 9th if the debt ceiling is not raised.

This is a major problem facing the markets. The last time this happened in August 2011 the markets collapsed and S&P cut our credit rating. The battle lines are being drawn ahead of lawmakers return to Washington on Sept 9th. The battle will begin in earnest in early September.

This is going to be severely detrimental to the markets. Add in the FOMC meeting on September 17th and the German elections on the 22nd and it should be a rocky month. September already has the distinction of being the worst month historically for the markets and this one could be month for the record books.

Regardless of which excuse knocked the market to new two month lows there is likely to be further weakness ahead. The volume on Monday was lackluster at 4.6 billion shares but Tuesday saw that pickup to 6.23 billion and the highest volume in two weeks. A/D volume was 7:1 negative and the indexes closed at the lows for the day.

We can't disregard the decline because it was a low volume day. The internals are rapidly deteriorating and sentiment has turned bearish. When the oversold rebound from Friday collapsed to new lows that was a technical signal to head for the sidelines. With this being a holiday week of sorts and volume normally light we could see any additional selling really push the markets lower.

Today's decline on the S&P was a loss of -26 points to 1630. On Friday the S&P closed back above the 50-day average. Today the decline broke below the 50 and the 100 day and is now in free fall territory. The next material support is 1600 followed by the June lows at 1560, which is now the 200-day average.

I think my original target for the decline to 1560 is more likely than ever and depending on the comments out of Washington it may be too conservative.

S&P-500 Chart

The Dow rebound to 15,000 was crushed with the Dow losing -170 points today and -65 on Monday to close at 14,776. The Dow has fallen so quickly it is already very close to the June closing lows of 14,659. It seems very likely it will hit my original target at 14,400 and potentially a lot lower. Ralph Acampora said Friday he was expecting something in the 12,500 range as a possibility.

The Dow has fallen -882 points from the August 2nd high or roughly -5.6%.

Dow Chart

The Dow lost -1.2% on Tuesday and the Nasdaq fell -2.2%. Tech stocks had been the biggest gainers in the preceding week and they were the biggest losers when the headlines began flying. The Nasdaq spiked to 3684 on Monday and only -10 points from a new 13-year high. The Nasdaq crashed back to strong support at 3575 and has not yet gone into breakdown mode like the S&P and Dow. It is only a matter of time if the headlines continue to be negative and I don't believe that will change.

Nasdaq Chart

The Russell 2000 fell -2.4% on Tuesday after temporarily trading over strong resistance at 1040 on Monday. The reversal wiped out five days of gains and pushed the Russell to close at the August lows. ANY further decline would be very negative for sentiment as a lower low and support failure. The next support target would be 1,000 but I firmly believe that will eventually break with a potential retest of 950.

Russell 2000 Chart

The Syria situation is just getting started. When the coalition begins firing cruise missiles into Syria the real worry begins. Do they stand by their pledge to attack Israel? Do they start bombing neighboring oil facilities? Does Iran join the party? Does Russia interject its own force into the Mediterranean to counter the U.S. buildup?

We are entering a very volatile period where Syria, the debt ceiling, U.S. budget, FOMC meeting and German elections could combine into a volatile witches brew for the markets. Keep your stops tight and take advantage of any rebounds to sell your longs.

Enter passively, exit aggressively!

Jim Brown

Send Jim an email