The U.S. dollar surged and many stocks reported better-than-expected earnings, but the stock market was hit with its biggest sell-off in more than two months. The main culprit for the market’s woes again was the banking sector, and as investment manager Brian Lazorishak of Chase Investment Counsel put it, “This is a reminder that much of the mortgage mess remains unresolved” (Wall Street Journal). 

According to the Journal, “The Federal Reserve Bank of New York, BlackRock Inc. and Allianz SE’s Pacific Investment Management Co., or Pimco, were among the bondholders attempting to force Bank of America to repurchase $47 billion in soured mortgages packaged by Countrywide Financial Group, according to people familiar with the situation.” Bank of America Corporation (NYSE: BAC) fell 4.5% yesterday to $11.78.

Stocks opened lower following a rate hike by China’s central bank, the first in three years. The rate increase pushed the dollar, higher but had a negative impact on both stocks and commodities. The dollar had its best day in two months, up 1.7%. And Treasurys rallied on the rate increases from China. The 30-year bond rose in price with the yield falling below 4%.

International Business Machines Corp. (NYSE: IBM) fell 3.4% despite Q3 profits that rose 12% versus a year ago. Big Blue reported earnings of $2.82 versus analysts’ estimates of $2.76, and raised its profit expectations for the year. 

U.S. home construction rose with housing starts up 0.3% to 610,000, but building permits fell 5.6% to 539,000.

The Dow recovered about 60 points just before the close, following earnings from Goldman Sachs Group, Inc. (NYSE: GS) and Capital One Financial Corp. (NYSE: COF). But the late rally still failed to bring the Dow Industrials above the 11,000 mark.  At the close, the Dow Jones Industrial Average was off 165 points at 10,979, the S&P 500 was down 19 points to 1,166, and the Nasdaq was off 44 points at 2,437. The NYSE traded 1.3 billion shares with decliners ahead of advancers by over 4-to-1. The Nasdaq crossed 649 million shares with advancers ahead by 5-to-1. 

What the Markets Are Saying

It is amazing how often unexpected events occur that turn prices from a significant resistance zone. Just when stocks seem “bound to head higher,” as one pundit said on CNBC on Friday, an event occurs that drives them in the opposite direction.

On Monday, the S&P 500 hit a new closing high for the current rally, but with our internal indicators overbought and at stratospheric levels, I cautioned that a failure of any kind could reverse a near-term trend and drive stocks down.

I was, of course, thinking of a surprising shortfall in earnings from some big name company like Apple, Inc. (NASDAQ: AAPL). Well, Apple did report disappointing sales numbers, but that wasn’t what drove stocks lower yesterday.

China started the ball rolling by ratcheting up interest rates by 0.25%, and that, along with Apple’s projected lower outlook, started things off on a bad note. Then came the crushing news that the Fed, along with some heavy-duty institutions, was insisting that Bank of America live up to its obligation to repurchase mortgages packaged by Countrywide Financial, and the markets headed south as a new banking crisis appears in the works.

So with yesterday’s reversal, which turned into the worst day in over two months, the question now is not how high will the market rally, but how low will this reversal take stocks before some stability returns. For that answer, we turn to the chart of the S&P 500.

The drive from the August lows to Monday’s high terminated midway between the resistance zone of 1,174 to 1,210, but yesterday’s decline immediately eliminated the first line of support, 1,174, by closing at 1,166.

Old resistance zones on the way up now become support zones on the way down. The next support zone is at 1,150 to 1,175, and after that 1,131 to 1,150 with the significant support at the double-top breakout at 1,130.

The 20-day moving average at 1,156 could act as support, but yesterday’s thrust down was so violent that the 20-day will most likely fall today. The next significant conjunction of moving averages is that of the 50- and 200-day moving averages now at around 1,120.

Yesterday’s heavy selling confirmed that the overbought readings of last week from our internal and sentiment indicators were significant. The near-term trend is now down, so traders should focus on the short side of the market. The intermediate-term trend is still up, and investors will want to have cash available to take advantage of buying opportunities that will no doubt shortly occur.

Today’s Trading Landscape

Earnings to be reported before the opening include: Abbott Labs, Altria, AMB Property, Amphenol, ATMI, Audiocodes, BlackRock, Boeing, Check Point Software, Comerica, Complete Production Services, Delta Air Lines, Eaton, EnCana, First Cash, Genzyme, Great A&P Tea, Hudson City Bancorp, Inventure Foods, Journal Communications, Knight Capital Group, Lindsay Corp., Lufkin Industries, M&T Bank, Manpower, Marshall & Ilsley, Media General, Morgan Stanley, Piper Jaffray, Quest Diagnostics, SEI Investments, Sensata Technologies, Silgan Holdings, St. Jude Medical, Stanley Black & Decker, Temple-Inland, Textron, United Technology, US Airways, US Bancorp, USG, Watsco and Wells Fargo.

Earnings to be reported during trading hours include: AMR Corp.

Earnings to be reported after the close include: Alcon, Alliance Data, Amylin Pharmaceuticals, AptarGroup, Astoria Financial, Cohu, Core Labs, CoStar Group, Covanta, Cypress Sharpridge Investments, E*Trade, eBay, Ensco, Fidelity National, Forward Air, Graco, HNI, Intersil, Kinder Morgan Partners, Lam Research, LaSalle Hotel, Mainsource Financial, Mellanox Technologies, MKS Instruments, Netflix, Newfield Exploration, Noble Corp., NVE Corp., Platinum Underwriters, Raymond James, Robert Half, Rush Enterprises, Schnitzer Steel, Seagate Technology, Select Comfort, StanCorp Financial, Terex, Texas Capital, Total System, Tractor Supply, TrueBlue, Vascular Solutions and Xilinx.

Economic reports due: Bank Reserve Settlement, MBA purchase applications, EIA petroleum status report and Beige Book.

If you have questions or comments for Sam Collins, please e-mail him at samailc@cox.net.