Investors spent the weekend thinking about the Thursday-Friday speed rally and decided maybe they had been too hasty. Either that, or we finally got to see what the market looks like when the short sellers have been blown out of their positions.

The Dow Jones Industrials and Nasdaq Composite have both fallen by 5% since Friday, on lower than normal volume. Leading groups have been gold and banks, while techs have been stymied.

Clearly the market has decided that, at minimum, throwing another trillion dollars at the banking crisis will be inflationary. You can’t float that many bonds and flood the world with new paper and not cause inflation. You can argue whether deflationary forces, such as lower asset prices, will thwart the inflation in the long term, by which I mean a few years. But you can’t argue that flooding the market with brand-new money won’t cause the value of current money to be debased a lot sooner.

Fear of Inflation

A fear of inflation puts downward pressure on the dollar, which, in turn, leans over and puts upward pressure on commodity prices. No wonder crude oil had its biggest up day in 20 years on Monday, while gold also jumped (see also, “Cashing In on Coal Stocks“). There were some technical factors at work, and they were much softer Tuesday, but the moves were real.

Strangely, though, the market is paradoxically also fretting about the opposite problem. And that is the possibility that a deal won’t get done. Funny, huh?

Right after Treasury Secretary Hank Paulson went to Capitol Hill to explain why the entire financial system would collapse into a big hole if they didn’t write him a check for $700 billion in a week, congressmen and senators on both sides of the aisle said that they were with him all the way. Both Sens. Obama and McCain said the same. None of them really understand the economy or the market, so they figure they ought to just do whatever the former Goldman Sachs chairman says (“Hot-Button Election Issues & Your Portfolio“).

And yet over the weekend the American people sent a barrage of emails and phone calls to Washington, and sentiment was running 9-to-1 against the proposal. So now, lo and behold, a lot of our representatives have decided they are opposed to the deal unless, well, you know.

Unless it’s earmarked up with all kinds of exclusions and clauses that would shower some of that $700 billion on their pet causes. You have to understand that $700B is more than we appropriate to the Pentagon for a whole year (that’s $515 billion, not including wars of course—those are extra). So the hands will be out from every corner for a piece of the action. They might as well call it the Financial Industry Lobbyist Full Employment act, or FILFE, which is you lisp a little, comes out as "filthy."

Financial stocks were hit hard early this week, but not as bad as one might have expected given their gigantic moves over the prior two days. For now, you can put the action under the heading of "normal pullback," as it would be perfectly ordinary to see any big advance retrace about half of its steps before resuming. In prior years, this kind of action would take days and weeks, or even months, but since we are on Meth Time these days, everything is happening at lightning speed.

Levels to Watch

The number to watch now is the 1,199 level of the S&P 500, as that amounts to a 50% retracement of the Thursday to Friday jump. On Monday it closed at 1,208, and on Tuesday, 1,190. If we have more widespread selling that pushes the SPX deeply under that level, watch out—a quick retest of the recent lows is likely in the cards. Maybe then the Securities & Exchange Commission will ban not just short-selling, but all selling. That would stop the market from going down, for sure.

As you know from my past reports, I am very skeptical of the whole thing—the bailout, the short-selling ban, the big move up on Thursday and Friday, the works.

And yet I have to persist in thinking that somehow they’re going to find another way to spur this lame horse into action. I was wondering why I felt this way, other than my experience and intuition, when I received a note from my friend Tom McClellan, the famed technician and monetary liquidity expert whose dad invented the McClellan Oscillator.

Tom says he thinks active short-selling is foolhardy now that the Fed and Treasury are fully involved in the game. He said it’s akin to those T.V. nature shows about the wildebeests trying to cross the river even after the crocodiles show up. The Fed and Treasury are the crocodiles, waiting to catch late arrivers who might try to wade into the river with a short position.

"The arrival of the crocodiles into the river does not mean that the river-crossing operation is all over, but it does say that the game has changed," Tom says. "It takes a while for Uncle Sam to get his way, but he has a big war chest, and the Fed still has those proverbial helicopters to drop money out of and increase liquidity. The Fed came in hard and strong after the 9/11 attacks, and basically opened the till for any bank to take money that it needed, but the stock market still took another week to reach a bottom once trading was restarted. Once it did find a bottom, all of that fuel from Fed easing brought about a big FAHWOOOOMP!! of a rally, like a charcoal barbecue."

I agree with Tom for now, but I will also point out that the Fed’s money didn’t last too long after 9/11. The SPX went from a low of 944 two weeks after the Sept. 11 attack to 1,173 in early December, a 24% move. But then it hit the 12-month average on the nose and then went on to fall by 35% to a low of 768 eleven months later.

Since everything is happening on speed-dial these days, figure the Fed-fed rally could last anywhere from two to six weeks rather than three months. Just to throw out a date, in case everything is moving up nicely by then, we’ll look for a downward reversal around October 10, which just so happens to have been the date of the top last year.

I continue to think that there’s a strong possibility that the market will stumble higher over the next few weeks before getting thwacked (see, “Don’t Play ‘Risk’ With Your Retirement.“)

Let’s keep focused on the 12-month average of the S&P 500 as our guide. If the SPX trades above 1,362 at the end of a month, then you can start to get excited. That would have to be confirmed by a second monthly close above that level. If a rootin, tootin’ rally really does get going after that, the next big barrier will be 1,440—the May high.

My guess is that bears would not let that line be crossed, and they would get a lot of help from fears of a prolonged recesson by then anyway. But let’s cross that bridge if we come to it. For now, focus on trading on the long side by checking out my Trader’s Advantage weekly newsletter, where we’ve had lots of success on both sides of the market  this year every step of the way.

This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights like this, visit www.InvestorPlace.com.