Headlines from geopolitical events, economics and earnings finally overloaded the market as we moved into the seasonally weak period in August.

Market Statistics

Ask 20 analysts why the market declined last week and you will get 20 different answers. Some will say economics were the culprit because the economy is starting to accelerate and the Fed will be forced to raise interest rates sooner than expected.

Some will say it was the numerous geopolitical events. Russia is increasing its cross border attacks on Ukraine and moving additional troops, tanks and heavy weapons systems back to the border. Apparently Putin is not going to back away and does not care what U.S. and EU sanctions are put in place.

Russian jets have been probing air defense zones all around Russia. NATO jets were scrambled to "identify" approaching Russian fighters on the border with Estonia. Fighters also encroached on Polish airspace and Ukraine airspace. A Russian drone was shot down near Kiev in the Ukraine. Putin said the sanctions had caused "serious damage" to international relations but he continued to deny all of the above events plus any involvement with the Ukrainian rebels.

Corporate earnings warnings as a result of the sanctions on Russia are already beginning to appear. Adidas cut growth targets as a result of the sanctions and the growing weakness in the European economy. Anheuser-Busch InBev said beer sales in Russia and the Ukraine had fallen off sharply. Lufthansa said the conflict had dramatically impacted air traffic in Russia and Europe. The Siemens CEO said it was clear the sanctions would have a serious impact in the German economy in the second half of the year. Germany is the strongest economy in the EU but it is also the most heavily dependent on commerce with Russia. Germany's VDMA machine makers association cut its growth forecast by 3% saying the conflict is "impairing demand in important export markets" because of the uncertain impact on the EU.

The 72 hour truce between Israel and Hamas was broken by Hamas within 90 minutes of it being put into place. The odds of a new truce are nearly zero.

ISIS is reportedly preparing an attack on Baghdad and increasing their reign of terror in the areas they have already captured.

The fighting in Libya is increasing. The Greek navy evacuated 186 people from Libya using helicopters and the frigate Salamis. Greece suspended operations at its embassy due to rising security issues. The U.S., France, the Netherlands and the U.K. have also suspended operations and evacuated personnel.

Iran announced on Wednesday it now had ballistic missiles with multiple warheads able to hit U.S. military installations all over the Middle East. The missiles are supposedly significantly more accurate than existing models and have much greater destructive power. The warhead(s) have a total weight of 746 Kg (1,650 lbs) of conventional explosive. Many of Iran's claims are not verifiable but they have been working toward this goal for several years. This is a prerequisite technology to being able to launch a nuclear warhead and nuclear payloads would weigh less than 746 Kg.

Banco Espirito Santo has failed after losing 3.6 billion euros in the first half of 2014. Several other entities related to the Espirito Santo ownership family have filed for bankruptcy. The Bank of Portugal is trying to arrange some emergency financing for the bank but there are growing concerns it may be allowed to fail because the problems are too large for a bailout.

Argentina defaulted on its debts for the second time in 14 years. The International Swaps and Derivatives Association (ISDA) ruled Argentina's default was a "credit event" and holders of those credit default swaps will be able to collect up to $1.5 billion in insurance. The country defaulted on a $534 million interest payment on Wednesday. U.S. banks may be on the hook for some of the defaulted loans or for selling the credit default swaps. Citigroup has already warned it will incur some losses. JP Morgan said there were some $682 million in contracts tied to global emerging market Credit Default Swap Index that will also need to be settled.

If those headlines were not enough to crater the market the realization of interest rates rising sooner rather than later definitely helped to grease the skids. Richard Fisher, president of the Dallas Fed, said the timing of the first rate hike has definitely moved "significantly" closer as a result of the strengthening economy and higher inflation. Charles Plosser believes the beginning of rate hikes should be moved closer as the result of "considerable economic progress." Also, "The funds rate setting remains well behind what I consider to be appropriate given our goals."

Various members of the Fed expressed concern that inflation was increasing too rapidly and the Fed no longer had the option of leaving rates at zero for a "considerable period" after QE ends. That phrase may disappear at the FOMC meeting in Mid September.

Everyone has known for several years the markets would react negatively when QE ends and when we are approaching the first hike in rates. With QE slated to end in October and the first rate hike likely to be in Q1-2015 the market is simply anticipating these facts in light of the considerable headline events overseas.

Art Cashin said the markets are "pricing in prosperity" and he was right. The economy is improving and everyone can see the future from here. That future is a Fed that is faced with rapidly rising inflation and the need to raise rates to combat that problem.

You can pick a reason out of the list above and blame it for the market decline. One analyst said "This market was a Titanic in search of an iceberg." In reality I believe it was an "all of the above" event coupled with overbought conditions and a high number of guidance warnings for Q3.

Friday had the biggest economic report for the week in the Nonfarm Payrolls. The headline number dropped from the upwardly revised 298,000 in June to 209,000 for July. This was below the consensus estimate of 235,000. The May number was revised up by +5,000 jobs and the June number by +10,000 jobs. The unemployment rate rose from 6.1% to 6.2% as a result of 329,000 people joining the labor force. The broader U6 unemployment rate rose to 12.2%. The labor force participation rate rose from 62.8% to 62.9% and a four month high.

The average workweek remained at 34.5 hours and the average hourly earnings were also unchanged. Year over year wage growth is around 2% and consistent with the last 24 months. The number of workers involuntary employed part time declined from 7.54 million to 7.51 million.

The lowest paying jobs in leisure, hospitality, retail and temporary help accounted for 25% of the new jobs. The lack of material wage growth is keeping millions of workers on the sidelines. It is more profitable to remain outside the system and collect welfare and supplemental benefits than go to work and earn a minimal wage. Obviously until they actually do go to work and gain experience and seniority they will continue to be faced with minimum income potential.

The economy has added more than 200,000 jobs per month for the last six months and that has not happened since 1997. However, July's gains were the lowest in four months. The economy is improving but it is not really accelerating. In the long run this is the best outcome because it will keep wage inflation at bay and keep the Fed on hold for a while longer.

The final revision of the July Consumer Sentiment improved slightly from the initial 81.3 reading to 81.8 at month end. The present conditions component rose from 96.6 to 97.4 and the expectations component declined from 73.5 to 71.8. This is really strange because in the separate Consumer Confidence report last week the expectations component soared from 86.4 to 92.7. Both surveys do ask different questions but you would have thought the general trends would be the same.

The ISM Manufacturing Index rose nearly 2 points from 55.3 to 57.1 in July. That is the highest level since December. It suggests the late winter weakness has passed and plants are moving back into full production. The new orders component would seem to substantiate that with a rise from 58.9 to 63.4. However, order backlogs barely improved from contraction territory at 48.0 up to 49.5. Export orders declined from 54.5 to 53.0 and inventories fell from 53.0 into contraction at 48.5. Employment rose from 52.8 to 58.2.

The only components to really post solid gains were the new orders and employment. Since the rest of the components are either production or delivery related it may be too early in this cycle for them to show the impact from the surge in new orders.

Of the 18 industries surveyed by the report 17 were reporting new order growth. The only sector not reporting order growth was wood products. Customer inventories declined -3 points to 43.5 and well into contraction territory. This suggests the customers are not confident the rebound in the economy will continue.

A coincident indicator of manufacturing activity is a reported shortage of wood pallets. All other manufacturing commodities were reported to be available in sufficient supplies. If there is a shortage of pallets it means goods are being shipped in decent quantities.

Conflicting with the ISM the Markit Economics index of U.S. manufacturing declined from 57.3 in June to 55.8 in July. The employment component declined to 51.2 and the lowest level since June 2013, down from 54.0 in June. Markit surveys 600 American manufacturers for this report.

Construction spending for June declined -1.8% and the biggest decline since January 2013. Private non-residential spending fell -1.6% and residential dropped -0.3%. Public spending fell -4.0%. Overall private spending is up +9.2% since June 2013. Overall public spending is down -2.9% for the same period. Spending on highways and street construction fell -10.9% for the month and -8.5% since the prior June. Much of this is related to the expiration of the Federal Highway Trust Fund. Congress approved a temporary bill to supply additional funding late in the week and they will take up the issue again in early 2015.

Moody's Construction Spending Chart

Vehicle sales for July declined from an annualized pace of 17.0 million in June to 16.5 million in July. Auto sales fell from 8.3 million to 8.0 million. Trucks declined from 8.6 to 8.5 million. Ford and GM sales rose in the low single digits but Chrysler sales rose +15%. Nissan sales rose +7%, Toyota +7% and Honda declined -8%. The market share held by U.S. brands fell below 45% and the lowest level this year.

The average age of a vehicle in the U.S. is over 9 years. The average incentive package on a new car has risen +10% to $6,000. Pent up demand is expected to continue into 2015 and then slow to a pace of 15.5 million vehicles.

The economic calendar for next week is very sparse. Compared to the high profile reports last week there is nothing that should rock the market. The ISM Nonmanufacturing on Tuesday is the most important and given the recent trend in reports it should post a slight gain and be ignored.

The quantity of earnings on the calendar for next week is beginning to fade. The number of stocks I could find to highlight declined significantly. The most watched are probably going to be AIG, KORS, DIS, FSLR, GMCR and MNST. After this week the number of companies reporting declines significantly.

Earnings for Q2 have now averaged 7.6% earnings growth and +4.0% revenue growth. These numbers have been very volatile. Two weeks ago analysts were predicting 5.9% earnings and last week they were predicting 8.3% to 9.0% when the reporting cycle is over. Those estimates faded somewhat over the week after some earnings misses by numerous companies. Earnings for Q3 are still being forecasted at 9-10% despite the 37% of the S&P-500 that has given negative guidance for the quarter.

Stocks reporting on Friday were headlined by Berkshire Hathaway (BRK.B). Earnings jumped +41% thanks to a stock swap deal completed earlier this year. Earnings rose to $6.4 billion or $3,889 per Class A share. Revenue rose +11% to $49.76 billion.

The stock swap was a deal to acquire a Miami-based TV station from Graham Holdings in exchange for most of its shares in the company that once owned the Washington Post. Berkshire and Graham exchanged assets worth roughly $1.1 billion. Berkshire claimed that $1.1 billion in Q2 because that is when the deal completed. Without the stock swap the adjusted operating earnings rose +11% to $4.3 billion or $2,634 per share. Analysts were expecting $2,485.21 per share. Berkshire had $55 billion in cash at the end of the quarter so they have plenty of capital for that next acquisition. One analyst said Buffett is piling up cash so he must not see anything of value in the market.

BNSF railroad added $916 million in profits. The utility division added $375 million thanks to the acquisition of Nevada's NV Energy and the insurance division produced $411 million in profits. Berkshire shares fluctuated significantly at the open with a dip to $122.72 but they closed fractionally positive at $125.87.

The CBOE (CBOE) reported earnings of 50 cents that were in line with expectations. Revenue of $143.9 million was a decline from $150.8 million but beat estimates by about $200,000. The company said trading volumes had declined significantly and they were going to slash expenses from a median range of $193.5 million to $188 million for the rest of the year. Average daily volume declined -3% to 4.83 million contracts and revenue per contract declined -4% to 32.2 cents due to higher volume based incentives for some multiple listed options. On July 30th the CBOE board approved the purchase of an additional $100 million in stock. This comes after a similar approval in December. In Q2 the CBOE repurchased $51.1 million in shares. Shares declined -$2 on the earnings news but rallied in the afternoon to gain $1.24 and close at the high for the day.

Probably the biggest surprise of the day came from Procter & Gamble (PG). Adjusted earnings were 95 cents compared to estimates for 91 cents. Revenue declined to $20.16 billion and missed estimates for $20.47 billion.

The surprise did not come from earnings but in the commentary that came with the earnings. The company is going to drop up to 100 of its current brands leaving it with just the 70-80 top performers. The well known maker of consumer products everyone uses did not disclose which brands they are going to drop but noted that collectively they account for less than 10% of revenue. They recently sold off Jif peanut butter, Folgers coffee, Pringles chips and Iams pet food. PG started selling Ivory soap in 1879 and helped coin the term "soap opera." The company has 22 individual brands that produce more than $1 billion in annual revenue each. Another 19 brands bring in more than $500 million each. Brands like Pampers, Tide and Crest will not be on the chopping block. Shares rallied $2 on the news.

Chevron (CVX) reported earnings of $2.98 or $5.67 billion compared to estimates of $2.66. However, production declined -1.4% to 2.55 million barrels of oil equivalent per day (mboepd), down from 2.58 mboepd in the year ago period. The company is spending more than $20 billion on five new projects to significantly boost production by 2017.

Earnings were boosted by $750 million in asset sales and removing those onetime items would bring earnings below estimates but no specifics were given.

Chevron said production increases in the Permian Basin and Marcellus Shale were offset by declines in older fields elsewhere. The legacy oil companies like Chevron and Exxon have billions of barrels of reserves but most of their reserves are in older fields that have been producing for decades and the 5-7% annual declines in those fields are very tough to make up elsewhere. For instance Chevron produced 2.55 mboepd. Using the median decline rate of 6% per year that is a loss of 153,000 boe every day, every year. That means they have to discover, develop and produce another 153,000 boepd every year just to stay even. Since Chevron and Exxon are both reporting production declines the task is proving to be very formidable. For Chevron this is the equivalent of adding the entire production of Continental Resources (CLR @ 152,400 Bpd) every year.

Exxon (XOM) reported a 5.7% decline in production to 3.84 mboepd and the lowest level since 2009. That is almost the same level of production from 10 years ago. Exxon is spending tens of billions per year on exploration and development and they can't keep up with the decline rate. Exxon has to discover, develop and produce an extra 218,800 mboepd every year just to maintain its existing production rate. Actually boosting production to new levels is nearly impossible.

Chevron shares lost -$1.34 on the earnings news.

The market finally gave in to the headlines last week. You can take your pick of headlines from which to assign blame. The key is that the market support finally failed. However, even with all the anguish over the big red candles the major averages only lost about 3% for the week. It is not the end of the world. So far it is just a pause in the trend BUT it has the potential to become something worse.

Nobody should be surprised the decline appeared. For the last two weeks I have been cautioning about reducing position sizes and tightening stop losses because I expected the market to pause after earnings. August and September are the worst months for the year and they are even worse in midterm election years. The market will always find an excuse when it is ready to take profits.

I pointed out last weekend that the Industrial ETF (XLI) had crossed below the S&P and appeared to be a warning signal of an impending market decline. That divergence accelerated early in the week and the Dow followed the XLI down.

I pointed out that the high yield junk bonds were collapsing and appeared to be indicating a risk off mode and a decline in equities could be near. That decline in junk bonds turned into a crash last week.

On Tuesday night I pointed out the Dow Transports were signaling the potential for a sharp decline in the Dow. The Transports has declined -400 points in the last seven days. The chart suggests we should see the Transports retest the 100-day average or at least the support at 8,000.

Complicating the life of U.S. investors is the breakdown of the markets in Europe. There are multiple problems in Europe. The region already has very slow growth and almost zero inflation bordering on deflation. Now that several rounds of sanctions have been enacted it is only going to get worse.

There is almost no scenario that Europe does not fall back into a recession as a result of the sanctions and the uncertainty surrounding the Russian incursion into the Ukraine. Since Putin shows no indications of backing down the odds are very good the sanctions will have to be increased and that will choke out any remaining growth in Europe and especially in Germany.

If Russia decides to really fight back and cut off oil and gas supplies to Europe the damage will be severe. Of course he would be hurting himself since Russia depends on that energy revenue. One alternative would be to hike the prices he charges to inflict even more pain on Europe. More than 30% of the natural gas used in Europe comes from Russia.

The Euro is imploding on the outlook for the European economy. The dollar has risen to a ten month high on relative economic strength and the potential for the Fed to raise rates in the future.

International companies are going to suffer significantly from the fluctuations in the currencies as well as the shrinking European outlook.

All of these factors are going to impact the U.S. equity markets. When external forces impact our markets the first impulse is to take profits. As those forces intensify the profit taking turns into defensive selling. Traders go to cash and wait for the smoke to clear. The U.S. retail investor lives in a fog. They worry about making a buck at their job, spending some time with their kids when they get home, catching a little TV and going to bed. They are not involved in the complex world of geopolitics, currency fluctuations, European recessions and debt default. When these events are thrust upon them they are like a deer caught in the headlights and unsure what to do next.

They are going to turn on CNBC, Fox Business News or Bloomberg and see what is going on. If you have been watching stock TV over the last several days the analytical coverage has been negative. People are suggesting we could see a 5-10% decline or worse. Whenever the market takes a dive the perma bears come out of the forest and find their way to a TV microphone. Are they right this time? Even a broken watch is right twice a day.

I don't profess to be a global macroeconomic guru. I don't even know one. I can't tell you what is going to happen in Europe other than it appears very likely they are going to at least fall back into a recession and one that could be deep. If Putin continues pressing his neighbors by sending fighter jets over their borders the potential for an escalation of the current conflict and/or the eruption of a new one in some other country is very possible.

If the European markets continue to decline you can bet the U.S. markets will follow suit. However, rather than worry about what might happen I would rather make plans for the worst and when it happens make lemonade out of the market lemons. I suggest investors do some research and pick out some stocks they would like to own at specific levels and then keep your fingers crossed they dip to those levels. I have found it is a lot more fun to hope for great entry points than worry about a major market dip. It is simply a matter of perspective. You can view the glass as half empty or half full.

On Tuesday I showed a chart of the Russell 3000 broad market index and pointed out that it returned to the 100-day average about once every three months. It had been 2.5 months since the last test. Friday was a retest of that average. Since December 2012 the index has retested the 100-day average 7 times, including Friday. The longest period under the 100-day was 4 days. Obviously I can't guarantee you the pattern will repeat but I think it is worth watching.

You can't play the Russell 3000 ETF (IWV) with options because the market maker has priced the spreads too wide. However, the S&P has almost exactly the same pattern so we can play calls on the SPY instead.

I am not advising anyone to rush into the SPY calls at the open on Monday. There is far too much uncertainty over Europe and a lot can happen over the weekend. I would rather see the markets chop around in the 1900-1920 range for a couple days and then buy some short term calls for an oversold bounce.

Here is my long term problem. The U.S. economy may be recovering but if Europe does appear headed for a recession then the U.S. economy is going to soften as a result. We sell things to Europe. The falling Euro and rising dollar is beneficial for anything we want to buy but Europe will not be buying as much from us.

We can take all the points I have discussed in this commentary and put them in a big witches caldron and stir them up. The market that appears from that mess is what we have to trade. We don't know how long the ingredients will have to cook before the uncertainty boils away but it is probably not just a day or two.

Remember, August is a weak month. Why rush back into the market at the first sign of green candles? The market is oversold and some of the worries will fade over the weekend but as long as Putin continues shelling the Ukraine and flying jets into the sovereign airspace of other countries we have the potential for events to worsen.

I would use the 100-day average on the Russell 3000 as our line in the sand. If we dip below it and then rebound that might be good for a short term trade. If we decline below it a second time I would consider that a warning of a deeper decline ahead and then we start watching the 200-day average at 1115.

Trade what you see and not what you want to see.

The S&P-500 broke through considerable support at 1950 and again at 1930 to close at 1925. The 100-day average is 1911 and it came within 5 points at the low on Friday. The S&P declined -50 points in two days and it is due for a short term oversold bounce. However, after sharp late week declines Mondays tend to be negative. It is not always true but quite often true.

Multiple analysts were talking about the 1920 level as decent support. While that may be true I think the round number at 1900 may be calling our name at least for an intraday low. That would look like the last two penetrations of the 100-day on the chart below. A brief punch through and then a rebound once sellers run out of stock. Short term resistance is now 1930 followed by 1950.

The rising wedge pattern on the Dow finally broke to the downside. We have been watching it for the last couple of weeks and a breakout/breakdown was imminent. The breakdown pushed the Dow well below its 100-day average at 16,541 and very close to the 200-day at 16,322. This is the third time the Dow has fallen below the 100-day in 2014. Normally the Dow is not reactive to moving averages because any one or two stocks can push the index around on any given day.

The Dow climb had slowed over the last couple of weeks and it has been 11 trading days since it set a new intraday high. The index has gone from overbought to oversold in about five days. There is light support at 16,450 and again at 16,350. The next material stopping point would be 16,000 if the selling continues. Initial resistance is well above at 16,725.

The Nasdaq Composite managed to close right in the middle of its recent support range. The intraday low of 4324 was well below the stronger support at 4344 but the afternoon rebound rescued it from a messy close. A move and close under that 4344 level would probably test the uptrend and the 100-day average around 4257.

The Nasdaq chart looks better than the Dow even though they both lost about the same percentage for the week. The Nasdaq rally is still intact above 4257. A break under that level would target 4000.

The Russell 2000 lost -2.6% for the week and is about to see the 100-day cross below the 200-day average. This would be negative for fund managers. The Russell is below all the major support points above 1096 making that sub-1100 level the next target.

I was actually encouraged that the Russell did not sell off a lot worse than the big cap averages. This suggests there was no panic and it was simply orderly profit taking and building up a cash reserve.

Resistance is 1150 and 1162 with support at 1096.

I view the Thursday decline as a confusion drop. Everyone was selling but everyone was selling for a different reason. There was not one big reason but a bunch of little ones that had been in the market already but each was finally starting to ripen into something that would stink up the place. To put it another way, there was a bearish reason for everyone.

Historically Mondays after a late week sell off are negative. Obviously not every time but more often than not. This happens to be a new month but not a new quarter so the retirement contributions will be light and should not impact the market to any great extent. I scanned the news late Saturday and did not see anything that was earth shaking but Sunday is normally the day the big headlines appear.

The breadth in the market has turned severely bearish. The number of stocks in the S&P that are trading above their 50-day average has fallen from 85% at the beginning of July to only 30.2% today. That has happened only four other times in the last two years.

I would continue to be cautious about adding new long positions until the market finds a bottom. It could be Monday or a month from Monday but it will eventually give us a pattern that will allow us to buy the dip. August has been down four of the last five years.

Random Thoughts

You can't make this stuff up.

The UN condemned Israel for possibly committing war crimes against Hamas. The crime was -- drum roll please -- not sharing their Iron Dome defensive technology with Hamas. The UN High Commissioner for Human Rights Navi Pillay told the media at an "emergency" meeting of the UN Human Rights Council that "Israel was falling short in its duty to protect the citizens in the Gaza Strip from getting killed by Israeli rockets and bombs." Also, "There is a strong possibility that international law has been violated in a manner that could amount to war crimes." The UN group said Israel outright refused to share its Iron Dome technology with Hamas. The UN also condemned the U.S. for helping fund the Iron Dome for Israel but not granting any such funds for those in Gaza. "No protection has been given to Gazans against the shelling."

IRS strikes a deal with atheists to monitor church sermons. The IRS settled a complaint by atheists by promising to monitor sermons for mentions of the right to life and traditional marriage. The Wisconsin-based Freedom from Religion Foundation (FFRF) sued the IRS claiming churches were violating their tax-exempt status by routinely promoting political issues, legislation and candidates from the pulpit.

The FFRF has temporarily withdrawn its suit in return for the IRS agreement to monitor sermons and homilies for proscribed speech that the FFRF believes includes things like the condemnation of gay marriage and criticism of Obamacare because of its contraceptive mandate. This monitoring is supposed to be done by the same IRS unit that was headed by Lois Lerner. This unit openly targeted conservatives and tea party groups so they should have experience that will help them in targeting churches. The IRS already asked the people in those conservative groups what they prayed about. I guess monitoring churches, which is a clear violation of the first amendment, is another way to suppress the exchange of ideas that are contrary to the current administration.

The FFRF claims the 1954 Johnson Amendment states that tax exempt groups cannot endorse candidates. A 2009 court ruling mandated that the IRS must provide staff to monitor church politicking. The FFRF claims the IRS has not adhered to the ruling and must immediately ramp up enforcement ahead of the coming elections. The FFRF says things like the Catholic Church's "Fortnight for Freedom" dedicated to opposing Obamacare's contraceptive mandate and Protestant and Evangelical churches holding a "Pulpit Freedom Sunday" are both politicking. The FFRF says such events at "rogue churches" have "become an annual occasion for churches to violate the law with impunity."

I am speechless. What has happened to America? Why does everything have to be controlled by the government? Our country was founded by people fleeing this kind of government-monitored and mandated theology. When will it stop?

The CIA has been busted for spying. Apparently they were spying on a Senate committee that was investigating the CIA. The CIA chief John Brennan initially said it did not happen but once he investigated he realized he was wrong. An inspector general report has now concluded the CIA did spy on the Senate. The Senate committee has produced a 6,300 page classified report claiming the CIA used enhanced interrogation methods - also known as torture - on terrorism suspects.

Monster bearish bet: On Thursday with the Volatility Index ($VIX) at 14.50 a trader bought 90,000 November 21/30 call spreads for about 70 cents each at a cost of about $6.3 million. The trade will only make money if the VIX continues to rise significantly from the Friday close at 17. Just to breakeven the VIX has to reach 22 and the levels where it topped in Dec 2012, Jun 2013, Oct 2013, Feb 2014. This very bearish bet is not one somebody would put on just to speculate on coming volatility. You would have to be pretty sure something dreadful was coming in order to risk $6 million that far out of the money. Do they expect another terrorist attack? What do they know that we do not?

Seadrill (SDRL) signed a $4.5 billion contract with Russia's energy giant Rosneft on July 29th, one day before the sanctions were to take effect. The contract for six high technology deepwater rigs is valid because it was signed before the sanctions took effect. Fadel Gheit, an energy analyst with Oppenheimer said "Putin knows these sanctions are all bark and no bite" and the Rosneft deal is just a way to get around any potential impact.

The day after the U.S. and EU announced more sanctions on Russia the country's deputy prime minister tweeted out the picture below in a jab at Obama's masculinity. The caption in the tweet said "We have different values and allies."

The Federal Reserve implemented the largest monetary policy experiment on record when they took interest rates to zero and began buying treasuries to lift us out of the last recession. The Fed balance sheet went from $800 billion to $4.5 trillion. The Fed has never successfully unwound a stimulus program without a market correction. Will the largest stimulus on record produce the largest correction on record when the Fed ends QE and begins to raise interest rates and unwind their balance sheet? Most analysts don't believe it will be a market disaster because the Fed does not have to sell the treasuries and mortgage backed securities back into the market. They can let them mature and roll off naturally. However, all the prior stimulus programs that ended badly did not have a QE component so even if the QE remains on the Fed's books the end of QE purchases and the hike in interest rates is definitely going to tank the market.

Thursday's market decline was in part due to the sharp +0.7% increase in the Employment Cost Index. That is the largest increase in six years and one more reason for the Fed to accelerate its stimulus removal process. Be prepared for some serious volatility over the next six months.

Banks could lose more than $1 trillion in deposits when the Fed starts raising rates. JP Morgan predicted it could lose $100 billion (7.8%) next year as rates rise and money flows to accounts that pay higher interest. Citigroup, Bank of New York and PNC Financial all said they were trying to determine their risk for outflows and the impact on the banks.

Banks are going to have to pay higher interest on deposits to keep those deposits at the bank. This will shrink margins at the banks and impact earnings. SNL Financial estimates that banks have seen deposits increase 23% over the last four years as a result of the Fed's stimulus programs. The cost of funding by those banks dropped to a ten year low because of the excess deposits. The Fed has talked about using a "reverse repo facility" as part of its exit. This will allow non-banks like money funds to have reserve accounts at the Fed and drain bank reserves.

NYSE margin debt reached a new high in early 2014 and remains near those highs today. If the expected "minor correction" turns into something more drastic we could see a real acceleration to the downside as stocks bought on margin are dumped when the margin calls appear.

"It's a Goldilocks report for an economy that is steadily expanding but not lifting off. It will reinforce the Fed's commitment to a gradualist policy approach" said Mohamed El-Erian of PIMCO in reference to the Nonfarm Payroll gain of +209,000 jobs. We will see how Goldilocks it was if the number declines under 200,000 for August.

August has been down four of the last five years. August is the worst performing month for the Dow, S&P, Russell 2000 and Nasdaq 100 since 1988.

Enter passively and exit aggressively!

Jim Brown

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"If the Arabs put down their weapons today, there would be no more violence in Israel. If the Jews put down their weapons today, there would be no more Israel."