Stocks Sharply Lower into Final Hour on Rising Credit Market Angst, Greater Financial Sector Pessimism, More Shorting, Profit-Taking

BOTTOM LINE: The Portfolio is lower into the final hour on losses in my Technology longs, Retail longs and Financial longs. I added (IWM)/(QQQQ) hedges and added to my (EEM) short today, thus leaving the Portfolio 75% net long. The tone of the market is very negative as the advance/decline line is substantially lower, almost every sector is declining and volume is heavy. Investor anxiety is above average. Today’s overall market action is very bearish. The VIX is rising 16.12% and is very high at 39.41. The ISE Sentiment Index is below average at 123.0 and the total put/call is slightly above average at .90. Finally, the NYSE Arms has been running very high most of the day, hitting 2.53 at its intraday peak, and is currently 2.22. The Euro Financial Sector Credit Default Swap Index is rising 10.74% today to 164.33 basis points. This index is down from its record March 10th high of 208.75. The North American Investment Grade Credit Default Swap Index is rising 4.18% to 185.26 basis points. This index is also well below its Dec. 5^th record high of 285.99. The TED spread is rising .71% to 98 basis points. The TED spread is now down 365 basis points since its all-time high of 463 basis points on October 10th. The 2-year swap spread is rising 5.91% to 62.75 basis points. The Libor-OIS spread is falling .30% to 90 basis points. The 10-year TIPS spread, a good gauge of inflation expectations, is down 6 basis points to 1.22%, which is down 142 basis points since July 7th. The 10-year TIPS spread bottomed at .65% in October 1998 during the Asian financial crisis and at 1.24% in October 2001 during the technology bubble-bursting meltdown. The 3-month T-Bill is yielding .12%, which is down 1 basis point today. Financials, REITs and the most cyclical shares are under the most pressure today. Much of today’s weakness is likely related to profit-taking after recent sharp gains, however the large jump in the euro financial sector credit default swap index is a large negative. As I suspected last week, the US Dollar Index is busting up through its 50-day moving average today. I expect this index to continue to trend higher over the intermediate-term. While US stocks likely have a bit more downside in the near-term, I still suspect the pullback will be relatively mild and short-term in nature. Too many large funds are too short or underexposed to US stocks and will likely look to cover quickly on signs of stabilization. Nikkei futures indicate a -225 open in Japan and DAX futures indicate a -9 open in Germany on Monday. I expect US stocks to trade modestly higher into the close from current levels on short-covering and bargain-hunting.