WE ARE STILL UPSIDE DOWN ON OUR BEARISH POSITIONS BUT FRIDAY'S ACTION DEFINITELY HAD THEM MOVING IN THE RIGHT DIRECTION!

This past week the markets traded slightly higher until Friday when they hit a big bump in the road...

WE ARE STILL UPSIDE DOWN ON OUR BEARISH POSITIONS BUT FRIDAY'S ACTION DEFINITELY HAD THEM MOVING IN THE RIGHT DIRECTION!

Several open positions jumped into the profit zone Friday morning only to reverse as short-covering drove the markets higher into the close--so on several positions we're within striking distance of the profit zone. We did get stopped out of our SDS play at a loss this past week--which is a shame because that stop at 31.00 could end up being the low for the next few months. The thing is we need to have a stop somewhere and we followed our discipline and got out of the play--the key is how the rest of our trades will fare from here because one or two big winners could easily surpass the SDS.

The question now is whether the markets are ready to turn downward or was Friday's action just a temporary dip on the way to higher stock prices. To help get an idea let's take a good look at...

WHICH WAY THIS MARKET IS HEADED

The uptrend on the major indices is still intact although there are some bearish signals beginning to surface.

The SP-500 rallied above the 200-day, now at 1115 but can't seem to get over the 100-day average or horizontal resistance at 1128. Shorts loaded up every day last week but when the S&P fell to 1110 at the open Friday and held there for nearly four hours without any further signs of weakness the shorts had to cover and take profits going into the close. There is just too much news risk to hold a marginal position over the weekend but this week is a whole new ball game.

The Nasdaq hit major resistance at 2300--stalled and then reversed lower. We got the same end of day spike but the Nasdaq gained the least of the major big cap indexes for the entire week at +1.5%. The chip sector remains a drag on the Nasdaq and threatens to pull the whole sector lower.

Volume was extremely low this past week--Thursday traded only 6.4 billion shares and the average for the entire week was only 7.06 billion per day. Monday's +220 Dow gain was on volume of only 7.5 billion shares--far lower than the plus 10 million we've been seeing. Volume should only get lighter until after Labor Day which means we are going to see more triple digit swings on minimal news events.

The big market mover this week is the FOMC meeting on Tuesday. After Friday's disastrous jobs report the Fed is expected to announce some kind of quantitative easing program after the meeting and that is what the bulls are pinning their hopes on.

The Fed currently has about $200 billion in expiring mortgage backed securities and instead of just keeping the money they are expected to put it back to work in the market by either buying mortgages or treasuries. In theory that would keep rates low but they are already so low it's hard to understand how that would help.

The two-year note yield fell to another all-time historic low on Friday of less than 0.5%, and the ten-year yield fell to a fifteen month low at 2.82%. Goldman expects that yield to eventually fall below 2.5%. This is the problem that confronts the Fed on Tuesday--what can they do to stimulate the economy without pushing short-term rates to zero? And even if they did if there is little demand so even zero interest rates won't stimulate the economy as we saw in Japan over the last twenty years. The market is going to be holding its breath until the Fed announcement on Tuesday afternoon but the potential for disappoint is high.

The problem is too much bad debt that still needs to be wiped out before the economy can regroup, pick up the pieces at fire sale prices and begin real sustained growth. The longer that process is postponed the longer the economy will languish. Unfortunately most of the government's efforts are in direct opposition to this necessary process as bad assets are sustained through government stimulus.

In theory the private sector was supposed to have recovered before the government stimulus ran out but Friday's jobs report shows that isn't happening. The headline number was a loss of -131,000 jobs in July. However, there were 143,000 census terminations for the month plus a loss of 77,000 government jobs. Net of the census workers there was a gain of 71,000 private jobs---far less than the 150,000 analysts expected. In addition June's job losses were revised lower by -94,000 to a headline loss of -221,000.

The higher than expected job losses sent the markets into a spin on justified worries the economy is falling back into recession. The construction sector lost jobs again as builders cut back on payrolls now that the tax credit stimulus has ended. State and local governments are also cutting back on headcounts (finally) also because stimulus funds have run out--even the post office is laying people off.

Uncertainty about the economic recovery is keeping employers from committing to hiring new workers. If the economy were to fall back into recession then employers would be on the hook for termination payments, unemployment payments and the expense for bringing new employees on in the first place.

Unemployment remained at 9.5% but only because another 181,000 workers became discouraged and gave up looking for jobs. When the employment picture finally improves in 2011 that will rise to more than 10% as those discouraged workers come back into the job market. The wider U6 level of unemployment that includes those discouraged workers and under employed workers who took a part time job to pay the rent (8.5 million), has risen to 19.8 million workers. Only 58% of the employment population is actually working---the lowest level since 1983.

Goldman Sachs (GS) was the first big name bank to dramatically lower their economic estimates for the coming quarters. Goldman said GDP growth in early 2011 is likely to fall to +1.5% with a gradual pickup by the end of the year. Goldman says GDP is likely to average +1.9% for 2011 compared to their prior forecast of +2.5%.

Goldman expects the GDP for the rest of 2010 to average 1.5% compared to estimates of 3% last quarter. Goldman said the decline in estimates was due to congressional resistance to extending fiscal stimulus. They also expect the Core PCE Inflation to decline from its current +1.6% rate to +0.5% by Q4-2011.

In spite of some glimmers of hope reported over the past few weeks that have driven the markets higher and an encouraging earnings season the bigger economic picture is still very negative. To recap some of the most recent news--Gross Domestic Product rose by just 2.4 percent in the second quarter, down from 3.7 percent in the first. The ISM Manufacturing index dropped to a seven-month low in July. Plus pending home sales fell another 2.6 percent in June after a 29.9 percent implosion in May. And factory orders fell 1.2 percent in June after a 1.8 percent decline in May.

The most interesting phenomenon though is that in spite of a clearly slowing economy the market is STILL heading higher. Evidently many traders still believe the government can pull us out of this downturn but the only weapon it still has is a new flood of money and lower interest rates. The problem is that has been the government's approach from the beginning and the only real result has been a tripling of US government debt.

The economy continues to head lower while the stock market heads higher--one of the two has got to correct soon--the question is...

HOW DO WE MAKE MONEY ON IT?

The key is to gain exposure to any further rally while still leaving the door open to profit on the downside. We've got two plays lined up this week that are perfect set-ups to take advantage of this market.

We're covering the upside potential with a bullish play on a stock with powerful reasons to move higher--and it has been. The global push behind this stock's move, their incredible earnings and chart and some extremely efficient options point toward to high-odds profits on the right calls--a position we'll be jumping on first thing Monday!

Our next play is really poised to explode as low stock volume and increased likelihood of volatility drive this one through the roof. This is a sweet set-up and as you'll soon see the timing couldn't be better.

We've got a market on the verge of a big move and two new plays to take advantage of it so let's get going...

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