Stock markets around the world saw a 3% plunge on Tuesday morning. Investors had a lot on their plate and their first reaction was to hit the sell button - again. The European debt contagion was the main worry but rising tensions between North and South Korean didn't help. The euro currency decline continues to lift the dollar and that pushed commodities lower at the open. Commodities are also being affected by rising concerns that demand might slow down in China and in Europe, especially a Europe facing strict fiscal austerity measures.

Investors were also reacting to news that the Libor rate is rising quickly. The Libor rate is the rate banks charge each other for short-term loans. If this rate is rising it is a sign that banks are becoming distrustful of other banks. When banks stop lending to one another credit slows down and that slows down the global economy. The Libor has risen to its highest levels since July 2009. Meanwhile the distress in Europe is pushing money into the perceived safety of U.S. bonds and bonds have been surging for the last several days. The yield on the 10-year U.S. bond has fallen to 3.15%. It was 4.0% in early April. Yet I wonder if the world's appetite for U.S. debt has stalled. The Treasury department held an auction of 2-year notes this afternoon and demand was less than expected. Lately short-term U.S. treasuries have been very popular so today's auction performance could be a warning signal.

On top of all of this uncertainty and fear investors were facing the prospect of war on the Korean peninsula. South Korea has requested an apology from North Korea for sinking a S. Korean navy ship on March 26th, 2010 that killed 46 sailors. A multi-nation research team determined the boat was sunk by a North Korean torpedo. Instead of apologizing N. Korea has severed all ties with S. Korea and Kim Jong Il has ordered the country's 1.2 million-man army to combat-alert status. Tensions are mounting as N. Korea has banned the passage any S. Korean ships or planes through their territory. The U.S. navy is currently doing maneuvers with South Korea right now so hopefully North Korea won't do anything stupid.

The North Korean news makes for great headlines but the real story remains Europe. Investors are quickly losing trust. Germany's decision last week to ban short selling on certain securities has caused more turmoil and failed to stop the European markets for sliding lower. Now Germany is thinking about extending this ban. When countries start making arbitrary decisions about how their markets work without any notice investors big and small don't like it! Of course the real trouble is worry the debt contagion in Greece will spread to Portugal, Spain and Italy. The banking system in Spain was beginning to crack and regulators forced four Spanish banks to merge together in an effort to strength their balance sheets. I heard someone say that Spain's real estate market is so bad they have three-years worth of inventory on the market. Let's not forget Spain is struggling with 20% unemployment.

Economic news today was overshadowed by currency moves and the North Korea situation. Overall the economic data was positive. Consumer confidence soared to its highest levels since March 2008. May's reading hit 63.3, which was better than expected and well above April's 57.7. While this is a positive move it's a far cry from the last economic expansion back in 2007 where consumer confidence averaged about 97.

The Richmond Fed and Chicago Fed data came in positive. The Chicago Fed National Activity index came in at 0.29, which was the highest reading since December 2006. The Richmond Fed manufacturing survey came in 26. Numbers over zero are positive but this was a drop from 30 a month ago. I warned readers that we need to be on the alert for a slowdown in the economic data. This is only one report and one month doesn't make a trend but I'm concerned that the U.S. could roll over into the second half of a "W" shaped recession. A slowdown in the rate of growth across the various economic reports could be our signal the recession is getting closer.

The new home sales data doesn't come out until later this week but the housing sector underperformed today. The S&P/Case-shiller numbers were released and home prices for March declined. Some of the metropolitan areas are showing year over year gains but the U.S. national home price index fell 3.2% for the first three months of 2010. I am concerned that this trend will continue and 2010 could end up being a challenging year for real estate as foreclosures continue to rise.

I try to avoid politics in my commentary but for once Barney Frank said something that actually helped the markets. Frank is the House Financial Services Committee Chairman and he was quoted this afternoon as saying the current financial reform bill goes "too far" on derivatives trading. He suggested the language might get removed. This "news" gave financial stocks a nice bounce this afternoon and the sector recovered from a -3% decline to close in positive territory. The BKX and BIX banking indices are bouncing from a test of their 200-dma. Today's session looks like a bullish reversal pattern but it needs to see follow through.

Speaking of bullish reversals both the S&P 500 index, the DJIA, the Russell 2000, and the transportation index all appear to have a similar "hammer" candlestick. This is a bullish reversal pattern but I repeat it needs to see follow through. Fortunately these indices are either testing technical support near their 200-dma or they are testing a significant low so odds of a bounce higher are pretty good.

The S&P 500 index traded near the February 2010 low near 1044 and bounced. This could be the start of a multi-day rebound. Short-term traders might be able to use this as an entry point but do so cautiously. The 1100 level and the 200-dma are now overhead resistance for the S&P 500 and the prevailing trend is still down. My concern is that this bounce will probably roll over again. I'd like to see the market trade sideways and build a new base for it to consolidate and only then maybe we can talk about a new direction. The problems that caused this market correction have not gone away. Europe still doesn't know how they're going to solve this debt crisis. With the euro currency plunging it changes the trade situation for everyone. Suddenly Europe's imports from the U.S., Japan, and China are a lot more expensive. China is still trying to slow down its economy, which has an impact on the rest of the globe.

I hate to sound like a broken record but we remain hostage to the headlines in Europe. Many expect an overnight event like a major European bank going under but that has yet to happen. While Europe struggles to find a solution to their debt problem the whole region appears to be headed for the second half of a "W" shaped recession. The U.S. could be headed for the same fate in late 2010 or early 2011. This is a dangerous market to consider long-term bullish positions. Do so carefully and keep your position size small.

Chart of the S&P 500 Index:

Chart of the S&P 500 Index (WEEKLY):

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 late 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. Estimates were in the 3 to 5 million foreclosures over the next three years but a White House advisor was quoted with estimates in the six to ten million range over the next three years. This only reinforces my own belief that we will see another tidal wave of foreclosed homes in 2010 and 2011. 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