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Markets are under pressure this morning. Spain formally requested 100 billion Euros to recapitalize its banks. Yields on both Italian and Spanish bonds are rising. Financial stocks are being aggressively sold today.

Energy is another area that is selling off sharply today. August crude hit a session low this morning of $78.19. WTI crude has attempted to rally above $79 but failed and is trading at roughly $78.50 as I write.

The metals space is slightly higher today. Gold and silver are flat to slightly up today depending on when you check for a price. This area, as are all areas, remains volatile.

Last summer we saw a severe sell-off in the market. Chaos in Europe was clearly a major factor in the turmoil. During that swoon Europe received most of our attention. The same is playing out right now. Greek, Spain, Italy, who is next to ask for help? There are other things to consider in these volatile markets.

When the market sold off last year the economy was cooling off. Inflationary pressures were easing and the prices paid component in all economic measures was falling significantly. This decline in the prices paid component helped fuel the sharp advance we had at the end of last year and the sharp run higher to start 2012. Those that focus on the broader macro themes will say that the recent sell-off is due to the rise in inflationary pressure we saw at the end of last year and early this year. Oil spiked last year and then sold off. The market reacted favorably to lower energy prices. The same thing is playing out in 2012. Prices spiked higher earlier in the year and lead the turn in the market. Prices have fallen significantly over the past several months. They are reaching trough levels. Economic readings are reaching levels that often point to higher markets a few months down the road. 

Here are some things we all need to keep an eye on when analyzing the economic big picture. Lower oil prices act as a stimulus and typically help to revive the economy and lead to economic numbers that actually surprise to the upside. Regional PMI’s have been on the wane recently. Based on the relationship between prices paid and future economic activity we are reaching a trough level and can expect PMI numbers going forward to surprise to the upside. The decline in crude prices plays into the declining prices paid story. Lower crude oil inventories lead to lower prices paid by companies and leads to better earnings reports in the future.

The prices paid component bodes for strong earnings reports a few months down the road. What about earnings reports coming out next month for the second quarter of this year? The market is telling us that the second quarter earnings season could be quite rough. Second quarter reports and forward guidance could well be weaker than expected and lead to near term pain. Lowered guidance and lower prices paid could set the stage for better than expected earnings reports later in the year. Smart management teams will lower the bar to a level that will lead to positive surprises later in the year.

I can’t really offer any insights into what is going on in Europe right now. It is a mess. As to how the current turmoil is going to be resolved, only time will tell. Just as soon as you are certain there will be endless selling, a plan is favorably received. Just when you think European leadership has a handle on things they disappoint. The resolution will be clear in retrospect but right now there is an awful lot of uncertainty.

The technical picture has been a mess over the last few weeks. There have been false breakdowns and thwarted breakout attempts. To say the market is volatile is an understatement. We had all the major indexes move below their 200 day moving averages only to rally back above their 50 day moving averages. The most recent rally attempt fizzled last week and we are back at critical support levels. Support for the major indexes is being tested as I write. Support for the S&P 500/Dow/NASDAQ/Russell 2000 is as follows; 1323/12,550/2850/760. If all four levels give way then selling will intensify. If some but not all of the levels give way a positive divergence will develop and a rally attempt will likely ensue. 

Do not become solely focused on the level of the broad indexes. Remain vigilant on the individual names you own in your portfolio. The market is very split right now. Several stocks are in deep bear market corrections and many names are doing quite well. Rotate your portfolio out of names as they break down. Cash is fine to hold right now. Focus on the areas of the market that are working and keep or add to your winners.

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About Thomas J Smith CFA

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