A Broken Breakout

Tuesday registered the worst day for stocks on a presidential inauguration in history, and every one of the Dow-30 (DJI) stocks closed lower. But the selling was again triggered by mass liquidations of the bank stocks and, this time, it was European banks that received the scrutiny and retreated the most.

The Royal Bank of Scotland (RBS), down more than 70%, may face a record loss after being valued at more than $40 billion for 2008. The British government is thinking of increasing its stake in the company by converting preferred stock into common shares.

Barclay’s (BCS) fell more than 40% due to investors’ concerns that the government will take an equity stake in the company.

But, despite the heavy selling, there was some good news:

� Johnson & Johnson (JNJ) closed lower but reported earnings that exceeded expectations.

� Moody’s (MCO) returned TD Ameritrade (AMTD) to investment-grade status citing “significant improvement” in its operations.

� And IBM reported profits of $3.28 versus an expected $3.03, which may help the markets this morning.

At the close, the Dow (DJI) was off 332 points and closed at 7,949. The S&P 500 (SPX) was down 45 points to 805 and the Nasdaq (NASD) lost 86 points to close at 1,441.

The NYSE traded 1.7 billion shares, with decliners ahead of advancers by 9-to-1, and on the Nasdaq, 874 million shares traded with decliners ahead by 6-to-1.

The outgoing February contract for crude oil closed higher by $2.23 at $38.74 a barrel, and the Amex Energy SPDR (XLE) fell $2.48, closing at $44.06.

,p> The February gold contract gained $15.30 to $855.20, and the PHLX Gold/Silver Index (XAU) fell $2.48, closing at $44.06.

What the Markets Are Saying

On Tuesday, each of the major indices closed under support and registered the lowest close since November. In addition, prices closed below our internal Collins-Bollinger Reversal (CBR) signal of last Thursday, turned away from a likely stochastic buy, and did so on an increase in volume.

The CBOE Volatility Index (VIX) closed higher by 10.54, putting it at its highest price since Dec. 9.

The bears took control yesterday following an extended romp in the woods that lasted from late November until now. But a worldwide bank crisis brought investors back to reality with headlines from the U.K. of mounting losses, scandals, and firings (sounds like here).

Both the “500″ and the Dow Industrials fell below support, which for the 500 was 820 and the Dow 8,000. With that, there is little doubt that the markets will test their November closing lows at Dow 7,552 and S&P 752.

The “breakout” of January can now be said to have been a “false” breakout, which means that it drew in a host of bulls only to have them slaughtered at yesterday’s close.

Even with all of the bad news and tape action, it is still possible to have the stock market turn around, and to do that the market must close above Friday’s close of Dow 8,281. But the major technical support lines have given way, volume is up on the decline, and the CBR has issued a strong sell signal. The chances of a turn up are diminishing.

For those with new long positions, it is best to cover them at the earliest opportunity, which could occur this morning. And for those who find that the short side of the market is where you would feel most comfortable, the contra-Exchange-Traded Funds (ETFs) could reward you handsomely — especially if the November lows are crushed.

Today’s Trading Landscape

Earnings of note to be reported include: Abbott, Actions Semiconductor Co Ltd, Adtran, Air Products and Chemicals, Allegheny Technologies, AllianceBernstein Holding L.P., AMR Corp, Apple, AU Optronics Corp, BlackRock, Burlington Northern Santa Fe Corp, Celadon Group, Charlotte Russe Holding, CNH Global N.V. and Coach, Community Trust.

eBay, F5 Networks, Hexcel Corp, Hudson City Bancorp, iGate Corp, II-VI, Kinder Morgan Energy Partners, L.P., LaBranche & Co, McMoRan Exploration Co, MTS Systems, Noble Corp, Northern Trust, NV Energy, NVE Corp, Polycom and Popular.

Raymond James, Rurban Financial Corp, Sanmina-SCI Corp, Seagate Technology, SLM Corp, Somanetics Corp, Taiwan Semiconductor Manufacturing Co, Ltd, The Progressive Corp, U.S. Bancorp, UAL Corp, United Technologies, Wipro Ltd.

The following economic reports are due: International Council of Shopping Centers (ICSC) Chain Store Sales Index for Jan. 17, the Redbook Retail Sales Index for Jan. 17, and the January NAHB Housing Index.

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Sam Collins is a registered, fee-based portfolio manager who may be contacted at samailc@cox.net. You can also check out an archive of some of his most recent market outlooks by clicking here.