Amid additional weak economic data, the prospect of bankruptcy for one or more U.S. automakers, and a 60% one-week decline in Citigroup’s stock, the Dow and S&P blew through previous support levels last week to touch lows not seen since April 1997. For several weeks, we have discussed the October 10th low of 840 on the S&P 500 as a potential bottom for the current bear market. The market had hammered away at this low several timeson declining volume with positive divergences, building confidence that at least a short-term bottom was in place.  However, it was not to be as the S&P closed last Thursday at 752 and the Dow at 7,552.  Even after a furious last hour rally on Friday, the S&P lost over 8% last week.

Friday’s late rally was sparked by news the President-elect was set to nominate New York Federal Reserve President Tim Geithner as Treasury Secretary.  The markets applauded the move because Geithner has vast experience dealing with financial panics and is a key player in the current crisis, ensuring a smooth transition from Hank Paulson.  While the nomination removes some uncertainty over a critical position in the Obama Adminstration, Mr. Geithner clearly has his work cut out for him.

Markets opened trading today with good news to fuel an extension of Friday’s rally.  First, the federal government staved off what seemed like the imminent collapse of Citigroup, providing $306 billion in guarantees and injecting $20 billion in new capital.  Second, the President-elect hinted over the weekend that he was prepared to hold off on new taxes during the first half of his administration.  As a result, the markets rallied strongly to bring the two-day gains to 13.2% on the S&P 500 and 11.8% on the Dow Jones Industrial Average.

As the chart below shows, this rally has taken the S&P back to the previous support level, which now likely represents a strong level of resistance.  While today’s rally is welcome and was accompanied by many positive factors, such as broad participation and leadership by the financials, it is difficult to have any confidence that this is a turning point.  After all, we have seen numerous big rallies lasting less than a week, and each one was followed by a decline to new lows.  As a result, we took the opportunity today to raise cash, harvest tax losses for taxable accounts, and keep some powder dry for an eventual retest of the lows reached last week.

Weekly Update

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