Things are rough all over, from the nonfarm payrolls report (the worst in 4 years) to the continuing subprime crisis, to the major market averages, which are caught in a tug-o-war, day-by-day battle between the bulls and the bears. I don't usually like depending on the kindness (or the intelligence) of strangers, but the quickest fix for the current market is an immediate rate cut of at least 50 basis points. But as I mentioned more than once last week, I don't have much confidence in Bernanke and the Federal Open Market Committee.

Expectations for a rate cut are indeed soaring, evidenced by the behavior in the fed-funds futures pits. This backdrop is having a global impact, sending the Japanese Yen higher as concerns about carry-trade unwinding come to the surface. Yen futures are now trading just below their 160-month moving average, a trendline that marked a top on a closing basis in May 2006 and last month. From a short-term perspective, continued strength in this currency as the Fed remains under the spotlight would likely be a headwind for stocks, while a rejection from this long-term resistance could offer a tailwind. From a longer-term view, the unwinding of carry-trade concerns are overblown, as the dollar's relationship to the yen still remains well above the 2000 and 2005 lows, implying the "great unwinding" has been anything but, with the yen still far below its 2005 highs.

We may not get the 50-basis-point cut I feel is necessary, but we are likely to see a cut (if not ... watch out). I do have to wonder why Fed officials are waiting for the September 18 meeting. My sense is that they will try to hold off until the meeting (for reasons best known to them), but the market could force their hand if it continues to tank. The market environment is an interesting one right now ... the more it tanks, the more fear this generates among the bulls (who fear a crash) and the more fear it generates among the bears as well (who fear a rally from a rate cut).

As a result, I suspect that the CBOE Market Volatility Index (VIX) might not pop as high as it normally would on a straight market plunge, as the bears have something to temper their enthusiasm. It did strike me that Friday's 9% surge in the VIX was pretty modest under the circumstances, and it was a bit of a shock that it closed near the mid-point of its intraday trading range. But it did take out its 20-day trendline, which has negative implications should it hold above this level. And its short-term trend remains to the upside, following a pullback to support at the 20 level/50-day moving average. For anyone looking to protect existing long positions in this uncertain environment, short-term VIX calls are good hedge against outstanding long bets. I consider VIX calls to be superior "crash protection vehicles" to index puts. A VIX pop can cause these options to rally by fivefold or even tenfold, and your profit potential is not nearly as constrained by the passage of time or by intermediate market rallies as is the case when you hold index puts.

Turning to the technical backdrop, millennium marks on the Dow Jones Industrial Average (DJIA) will continue being a psychologically important phenomenon long after we're seeing Dow closes above 20,000. In the past 12 months, we've seen both the 12,000 and the 13,000 levels penetrated. 12,000 was breached to the upside in October 2006 and retested 4 months later in February 2007 (with a low at 12,086). The threshold was tested again in March of this year (low was 11,939).

The 13,000 level was initially hit in April 2007 and retested once again 4 months later in August 2007 (the lowest close during the recent pullback was 12,845, hit on August 16). Even through the tumultuous price action of the past 2 weeks, 13,000 has held steady.

I know I continue to hammer the point of the Russell 2000 Index's skirmish with the 800 mark, but the battle continued to rage during the past week. The small-cap index closed Tuesday's rally at 800.69, barely managing a close above the key century level. Of course, this victory was fleeting, as the index opened lower the subsequent session and then proceeded to plunge - a scenario that has followed several recent forays to the 800 level.

Finally, the 1,500 level on the S&P 500 Index has become a significant area to monitor. Previously supportive in May and June, the 1,500 mark was breached in late July and has acted as resistance ever since last Tuesday, the index peaked at 1,496.4. The SPX's 80-day moving average is currently hovering overhead at the 1,500 mark, fortifying this region as one of resistance. On the flip side, the SPX seems to have found short-term technical support at the 1,450 level, which defined the index's intraday low on Friday. If this level wasn't part of the reason for late-day stability amid Friday's plunge, I can only assume it was the product of those with a very strong sense that the Fed will move to cut rates, perhaps even ahead of today's open.

Even as buyers took control in the final half hour on Friday, however, volume on the S&P Depositary Receipts (SPY) was not remotely climactic. By the session's conclusion, 235 million shares had traded on the ETF. This compares to 546.7 million shares on August 16 or 467.6 million on August 1. A short-term bottom such as the one seen in mid-August - typically coincides with volume that is notably out of the ordinary.

At Investors Intelligence last week, the percentage of bullish advisors rose to 42.9% on a week-over-week basis, rising from 41.1% the previous week. The lowest this reading ever got (during the recent pullback) was the week of August 21, when it hit 40.6% (while the bearish reading was at 37.4%). While I don't see this as critical, a drift to the bearish side in this survey would have been better news for the bullish contingent.

To summarize, I believe there is a very logical case for the August lows being a bottom of some significance. Major support levels have held and there was evidence of climactic bearish sentiment that continues to manifest itself in the cocky, "victory lap" mentality on display from a number of prominent bears. At the same time, corporate buybacks continue apace and corporate insiders are buying furiously, even as mutual-fund investors mob to the exits. The huge wild card in this equation is the Fed, which has the power to take this market down should it behave in a foolish manner by holding to its bogus inflation concerns or should it accede to the braying of those (many of whom are short the market or are sympathetic to the short side) who profess to be concerned about the "moral hazard" a rate cut will encourage. And there have been numerous pronouncements from Fed officials recently that lead me to conclude that a monumental policy error is by no means out of the question. (Let's not forget that just a few days before the 1987 market crash, rookie Fed Chairman Alan Greenspan raised rates in what was one of the biggest policy errors of all time.) I would therefore encourage investors to buy some portfolio protection in the form of call options on the VIX.

This week, we won't really get any further economic clues until Friday, which marks the release of retail sales for August as well as import prices. Earnings will remain scattered few and far between the most widely watched report will probably be the beleaguered Bear Stearns, which is scheduled to report next Thursday.

But mostly the next few sessions will be all about waiting for the Fed, and analyzing the crumbs of any Fed statements we're treated to in the meantime. Today brings remarks from the heads of the Atlanta, San Francisco, and Dallas banks, as well as a post-close address from Federal Governor Frederic Mishkin. One can only hope they are a little more sensible than those who spoke last week, but I somehow doubt it.

And now a few sectors of note...

Dissecting The Sectors

Sector

Base Metals/Copper Bullish

Sentiment: Options players continue to loiter in the bearish camps for 2 of our favorite metal names, Southern Copper (PCU) and BHP Billiton (BHP). Both stocks currently have Schaeffer's put/call open interest ratio (SOIR) readings near the 75th annual percentile, showing a definite lilt toward the pessimistic side of the fence. Combined on the pair of stocks, there are just 5 "buy" ratings, 8 "holds," and a "strong sell," meaning the analysts have yet to completely buy into the group's potential.

Outlook: PCU and BHP are currently sitting with respective year-to-date gains of and 94.2% and 61.5%. Freeport McMoRan Copper & Gold (FCX) is impressive as well and has recently remerged above its 10-day and 20-day moving averages. While copper futures have pulled back of late, testing support near the $3.30-a-pound mark and the 160-day moving average, metal miners and copper producers continue to look like solid plays. BHP is back in rally mode after testing its 20-week moving average in mid-August, and PCU has rallied back above its 10-week moving average. One thing to watch for with these stocks (on a longer-term basis) would be weakening demand should the global economy continue to slow, sending global metal prices lower.

Sector

Retail Growth Bullish

Sentiment: Some of our favorite names from this group Amazon.com (AMZN), Chipotle (CMG), Blue Nile (NILE) continue to step gradually higher despite the rockiness of the broader market. And this trio of solid-growth names remains underappreciated on Wall Street. Among the 3 of them, there are just 12 "buy" ratings, 23 "holds" and 5 "sells," meaning the chance for future upgrades is high. Short interest is a factor on all 3 stocks as well; the short-interest-to-float ratios stand at 17.8% for AMZN, 13.69% for CMG, and 24.85% for NILE. Options players are generally skeptical of the retail group, as Schaeffer's put/call open interest ratio (SOIR) for the AMEX Retail HOLDRs Trust (RTH) stands at 1.94, with short-term puts outweighing short-term calls by a margin of nearly 2 to 1.

Outlook: Last week was a decent one for the retailing group, as August same-store sales numbers were stronger than expected thanks to a solid back-to-school shopping season. The group reported a collective same-store sales gain of 2.9%, ahead of the 2.3% pace on a year-to-date basis. Focusing on retailers with strong growth prospects, relative-strength outperformance, and a decent backdrop of skepticism should continue to be a profitable strategy.

Sector

Financials Bearish

Sentiment: Options players are still trying to figure out rock bottom for the financial group - Schaeffer's put/call open interest ratio (SOIR) for the Select Sector SPDR Financial Fund (XLF) stands at 2.80, which is lower than 98% of the past year's data despite its seemingly high absolute reading. What's more, the composite put/call ratio rating for the brokerage sector weighs in at 0.84, a lower reading than 91% of all readings captured in the past year.

Outlook: Per Barron's, Friday afternoon's mid-session "rally" was led by the financial group, which saw a boost of buying power on rumors of a rate cut. Without this hope, the XLF would have endured a far worse day. Volume on the fund was miniscule at 75 million shares and light years away from climactic, suggesting that a retest of former lows might not be out of the question. But the 33 level could provide short-term technical support; it is possible that this region is strengthened by the160-week moving average.

Copyright Schaeffer's Investment Research http://www.schaeffersresearch.com

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