From the Gorilla

Gorilla Traders put out a nice article this week about the state of the Economy and I think it’s dead on:

 

August 20, 2011

It has now been two full weeks since that U.S. debt downgrade from Standard & Poor's wreaked havoc on global financial markets, and as much as the bulls had hoped the worries would pass, they have not yet dissipated. Last week's wild ride ended up evening out a bit, and the major indices closed out last week with modest weekly losses of 1% to 1.5%. This week started off well enough, but then the sellers stepped in and we unraveled a bit as the week wore on. When the dust settled Friday, we saw weekly declines of 4.0% for the Dow, 4.7% for the S&P 500 and 6.6% for the Nasdaq.

It was one of those weeks that last week's action was saying could not happen, and it was one of those weeks that rattles even he most bullish of bulls. Just when you think that the stock market might have ironed out its own problems, we get hit with a new barrage of problems that include everything from 400,000 new jobless claims to bad housing numbers and a sales warning from Dell (DELL). Ongoing chaos with regard to European reforms did not help much either, so you can see why the bulls closed out the week singing the blues.

What left the bulls most disheartened this week, however, was the weakness that kicked in despite how well stocks held up last week. We saw a big rally last Thursday and Friday, followed by a strong start to this week, but it was just not enough to keep the market's head above water. Last week's losses were manageable, but to tack on this week's 4% to 6% losses in the majors added insult to injury. We keep hearing about a "rebound" in the economy and the "ongoing recovery," but here we are once again looking at a potential recession that may have even already begun.

So how could we possibly be heading back into a recession given all of the "full-court-press" measures of the past few years? The main answer to that question can be summed up in one word, and that word is "BANKS." The "too big to fail (TBTF)” banks received hundreds of billions in bailout money, but if you are wondering whether this "grand plan" worked, you need only look at the big banks' stock market performance. They are painful to look at as of late, and they are the "canary in the coal mine" for the fate of the broader economy.

Even the TBTF banks know as Bank of America (BAC) is still in trouble, and they even announced the planned layoffs of 10,000 workers this past week. JP Morgan (JPM) is also looking like it is under pressure, and you can see this sector's demise by looking at the performance of the Banking Index (BKX), which remains unable to get out of its own way to the downside. How this slide is stopped is a big mystery, but we will not likely see much of an economic rebound in the broader economy if the banks continue to deteriorate.

So what tricks might the Fed have up its sleeve? Well, the Jackson Hole Fed Party is in just a couple of weeks, and we did get a breath of life known as "QEII" last year right around this time of year. Some Fed watchers say that a QE3 might already be in motion, and what we now need is a formal announcement from the Fed that it is, indeed, putting the monetary pedal to the metal right now to avoid a double dip recession. Again, play close attention to Gentle Ben this week at the Fed's annual powwow up in Wyoming.

Stocks are still looking vulnerable, and it was a major psychological blow for the bulls to see the Dow lose the 11,000 level. The 10,000 level would be even more disparaging, but at least that is not a major concern for the time being. The few "pluses" the Gorilla saw this week were oil down around $82 per barrel and yield on the 10-year Treasuries down around 2% (with brief dip below that level!). This means that gas and energy prices might remain calm, and it also means home and consumer loans will remain low for the foreseeable future. Those are positives, but they still do not fill the void generated by a stagnant economy.

So this week was rough, but it very likely could have been worse. Keep those seat belts fastened tightly, and we will see if the bulls can find some reason for a bounce next week.