Color Me More Concerned

This commentary originally appeared on Real Money Pro on Sept. 28.

Notwithstanding the continued unpredictability and volatility of the overnight swings in S&P 500 futures, there were some negatives in yesterday's economic releases and stock market behavior.

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As a consequence, color me more concerned regarding the market's short-term prospects -- and I am back into a market-neutral mode. If this week's rally extends into quarter-end (Friday) and the fundamental input doesn't change, tactically, I will consider getting back to a slightly net short position. An important issue that I have been raising has been whether the sentiment plunge in August would hit the hard economic data in early winter. Unfortunately, I think it is significant that consumer confidence rebounded only modestly from the disastrous reading in August. Moreover, the labor differential worsened for the fifth consecutive month -- not a good sign. Clearly, job growth and economic growth hold the potential of disappointing in the months ahead. Meanwhile, another bad sign yesterday was the financial stocks, which, at the peak, were the best performers of the day (as observed by BTIG's Dan Greenhaus), but, by day's end, they were among the worst. Bank of America (BAC), American Express (AXP) and JPMorgan Chase (JPM) all closed in the red. The markets and our economies are captive and beholden to policymakers (both here and abroad); it's a slippery slope where investors and corporations don't seem to be in control of their own destinies. Add this together with the manufacturing malaise I observed yesterday (shown again below), and I am afraid that we appear to be headed in the wrong direction.The National ISM (consensus is at 50.4), to be reported on Monday, will likely disappoint (and come in the high 40s) in the face of a compilation of all the now previously released regional ISMs. Consensus domestic economic expectations (and corporate profits) are clearly exposed to downside risk. As to equities, notwithstanding the market's dependency on the content of recurring eurozone news, the clear question is whether the sharp rally in the last two days has been discounted in what appears likely to be poor economic data (led by a weak national ISM expected for Monday) and the continued souring in consumer sentiment, which might accentuate the negative feedback loop.

Given these concerns, if the markets continue to advance, it might be an ideal time to cull out poor-performing stocks or companies that face earnings challenges in a disappointing and decelerating domestic economy.

Now, let's move on to a technical observation.

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A famous Woody Allen quote -- used by Warren Buffett previously in his annual report and letter to Berkshire Hathaway (BRK.A)/(BRK.B) shareholders -- has some bearing on our analysis of the markets: "Bisexuality immediately doubles your chances for a date on Saturday night." In other words, embracing both fundamentals and technicals can have its benefits. Earlier this year, I raised the issue that an unusually negative technical formation, "Three Peaks and a Domed House," might have indicated that an important market top was being made in March-April 2011. This observation, which caught a number of technically inclined analysts by surprise, with the benefit of hindsight, might have been prescient. Technical analyst George Lindsay coined this 23-step "Three Peaks and a Domed" technical pattern and gained celebrity because it pointed to a market peak in late 1968 -- and the largest stock market correction since World War II followed in the years after. (Here are some historic examples of such a technical setup.) Below is a chart of S&P 500 cash year-to-date. Observe the similarity between the chart above and George Lindsay's "Three Peaks and the Domed House" technical configuration below (with points 3, 5, 7 and 9 corresponding to the S&P's March-April 2011 price action). Err on the side of conservatism in these uncertain (and market volatile) times. Doug Kass writes daily for Real Money Pro, a premium service from TheStreet. For a free trial to Real Money Pro and exclusive access to Mr. Kass's daily trades and market commentary, please click here.

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