KaBoom!

KaBoom could even be an understatement. Why?  Because after something collapses, it’s normal to expect that the danger is over and the healing process will follow.

After this week’s market debacle, it’s very probable there’s more pain to come.  The S&P500 dropped almost a hundred points last week, which is a 7.2% decline.  This is the largest weekly decline since the meltdown in March 2009.  Confirming the price collapse was the massive surge in volume.  Investors were desperately selling and seeking to avoid further damage.  Also confirming the sell-off was the spike in the VIX, which jumped almost 30%.

What was the catalyst for the drop?  Per last week’s list of triggers, it was the first item on the list—stress in Euroland.  As stated last week:  “if Italy and Spain keep falling, then look for an ugly reaction in risk assets globally.”

In a nutshell, that’s precisely what happened.  Growing stress in Euroland sparked fear of a global economic slowdown, and more immediately, a global financial credit crunch.  Put the two together and you get a huge sell off in risk assets, especially stocks.

The flow of ugly macro data continued to grow.  ISM manufacturing and services both badly disappointed. Personal spending and income were also lower than predicted. Initial jobless claims, as predicted here, crept back up into the recession-zone, or the 400,000+ range.  While more jobs were created in the headline jobs report, the overall picture was still very grim.  The only reason the unemployment rate ticked down was that a huge number of unemployed folks simply dropped out of the labor force, while the actual number of not working people rose! More non-working people were simply not classified as unemployed any more, so this made the unemployment number look like it improved.

Instead, the opposite is happening.  And two measures clearly capture the horrific employment situation in the US today.  First, the employment -population ratio fell again, now to a 25 year low. Second, the labor force participation rate fell, also to a 25+ year low.

Technically, the stock markets are badly damaged.  Most importantly, the S&P has closed for several days well below the 200 day moving average.  Its’ very likely that next week, the 50 day moving average will cross under the 200 day.  Known as the “Death Cross”, this will signal to a lot of market analysts that more selling is coming, so they advise clients to sell, which leads to a self-fulfilling prophecy……of more selling.

That said, the stock markets are very oversold.  As such, they’re due for at least some sort of modest bounce, but one that’s highly unlikely to lead to new highs over the next two months.

Two final points.

1. This blog for many months this year has been pounding the table arguing that the melt-up in stock prices since September 2010 was almost perfectly tied to the Fed’s QE2 program.  So when the program ends (June 30), we argued that the odds of stock market declines would rise dramatically.

Well, the test is over and the score, as of now, is a perfect 100%. Since July 1, the stock markets have pretty much been going DOWN every week.  Specifically, they finished last week down 11% since QE2 was shut down.  Not bad.

2. The pain is far from over.  Last night, after the market meltdown was history, the United States was downgraded by Standard & Poor’s. For the first time ever, the US is no longer a AAA credit. This is bad news, and will almost certainly scare risk asset markets even more.

And let’s remember, QE3 is not around the corner; Euroland problems are only growing; and all the other potential negative catalysts are still lurking out there.

The bottom line—while the damage to date has been notable, the damage to come….perhaps over the next 60 days….could be far more notable.

Prepare for the possibility of a bigger Kaboom!

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