The new year started off pretty strong but the rally ran out of gas. The late-January, post-earnings sell-off showed up just as expected. So why are stocks breaking down? Earnings have been generally better than expected but it's still too much cost cutting and not enough new sales. Management remains cautious about 2010 and it's that same cautious attitude that's going to keep hiring at extremely low levels.

The stock market is selling off because stocks essentially got ahead of themselves. The earnings results and forward guidance is providing a little dose of reality. Last week's economic data was actually pretty strong. The Q4 GDP came in at +5.7%, which was way better than expected. Consumer sentiment and consumer confidence is holding up. Manufacturing data has been improving. The inventory rebuilding phase is underway. All of this is good news. We can ignore the home sales data for now. Existing home sales and new home sales numbers plunged. It was THE worst month in history (of the report) because the first edition of the new-homebuyer tax credit that was set to expire in November pulled all the real estate sales forward. Residential sales this winter could be very bleak but that's another story.

Sometimes the market environment just turns bearish and no matter what the news is investors sell it. We had some pretty impressive earnings reports last week and AAPL finally unveiled their tablet PC. Yet traders sold it all. On a short-term basis stocks are oversold and due for a bounce. When the market does bounce I would not buy it. Nimble traders could use the next bounce as a new entry point for short-term bearish trades. The question isn't if stocks bounce but when? Will it be Monday morning or will stocks churn sideways as investors wait for the January jobs report that comes out Friday? In the mean time we'll also get the New York and Chicago ISM numbers.

Short-term I am looking for a 10% correction in the S&P 500. That means a drop toward the 1050-1035 zone. This should coincide with the 38.2% Fibonacci retracement from the S&P'5 bounce off the July 2009 lows. While we are looking for a 10% pull back that doesn't mean you have to buy it. There is no guarantee that just because the market dips 10% it's going to bounce again. Readers are encouraged to keep an eye on the foreign markets to see how they might affect the U.S. Right now the major European markets are close to a 10% correction and Asian markets don't look any better.

Talking about Asian makes me think of China and how the Chinese government's attempt to slow down their economy (not necessarily a bad thing) could really put the brakes on this global recovery. If China is easing back on the stimulus we could see more governments do the same. At this point it's too early in the game for pulling stimulus out of the system. The China news took a toll on commodities, which were hammered pretty hard in January.

The U.S. dollar is another major factor pushing commodities lower and the dollar is rising because the euro is collapsing. I won't bore you with the details but you may have heard that Greece could default on its out of control debt. EU officials and the stronger EU countries have a dilemma. Do they bail out Greece, which would set a precedent and probably lead to bailouts for Ireland, Italy, Portugal and Spain. Or do you kick Greece out of the EU, which then puts the other four countries on the chopping block. Either way the strength of the euro is in serious trouble.

In summary, investors are nervous. The S&P 500 broke through support at 1085 and now we're looking at the 1050-1035 zone. If that breaks then look for support near the 200-dma or the 1,000 level for the S&P. The dollar is breaking out and that will continue to put pressure on commodities and all of the commodity-related stocks. Don't try and pick a bottom in this market. Remember, it's dangerous to try and catch a falling knife. You normally get cut.

Chart of the S&P 500 Index:

Chart of the Russell 2000 Index:


Previous Comments on my Long-Term Outlook:

My long-term outlook has not changed. I still expect the economy to see a double-dip, "W"-shaped rebound with the second dip in 2010 (some analysts are predicting it will not show up until 2011). Lousy consumer spending, rising foreclosures, and lagging job growth will be the main culprits. Several weeks ago there were some comments out of the U.S. Treasury concerning foreclosures. The Obama administration's HAMP loan modification program can only help a certain number of homeowners and one official said that even if the HAMP program was a total success we should still expect millions of new foreclosures. This only reinforces my own belief that we will see another tidal wave of foreclosed homes in 2010 and 2011. Some analysts are forecasting upwards of six million foreclosures in the next three years. What is that going to do to consumer confidence and consumer spending? It's not going to help! You can review my long-term outlook here. It's the second half our my "Two Months Left" commentary.

~ James Brown