By Robert W. Colby, Senior Analyst

Testing Recent Lows
The Bad News: Credit Risk Fears Are Shaking Confidence.
The Good News: VIX volatility rose to a new 4-year high.

Need some good old fashion Deus ex Machina to save this market?

One bright spot: NASDAQ relative strength jumped to a new 15-month high, even though price fell.

Stock prices collapsed on news of new and worse credit problems. Prices closed very weak, on their lowest levels of the day, confirmed by heavy volume and Bearish Advance-Decline balances.

The major indexes fell nearly 3% for their biggest one-day losses since 2/27/07. The market hates uncertainty and, unfortunately, no one seems to have a clue as to how the current credit situation, most of which is private and hidden, might play out. The situation appears to be without precedent.

Unless there is some kind of major overnight Deus ex Machina (artificial event introduced suddenly to resolve a situation), it is hard to imagine traders wanting to buy stocks before the weekend. Some traders say they will remain on the sidelines until downside momentum dissipates. Their fear compels them to wait for the dust to settle.

The VIX “Fear Index” jumped to 26.48 on 8/9/07, indicating the greatest level of fear in more than 4 years. Options traders were feeling very Bearish, which is Bullish according to the Art of Contrary Opinion. VIX has closed above its 10-year average for each of the past 10 trading sessions. VIX is a market estimate of expected constant 30-day volatility, calculated by weighting S&P 500 Index CBOE option bid/ask quotes spanning a wide range of strike prices for the two nearest expiration dates.

Stocks became very oversold during the recent 15 trading-day downside shakeout. Price momentum oscillators such as RSI and Stochastics hit their most Bearish extreme lows on 7/27/07 and demonstrated positive divergences since then by failing to confirm lower lows in price.

As of Thursday’s close, both oscillators and price indexes appeared to be testing recent lows, which is quite a normal technical phenomenon. There is little technical evidence to suggest that the lows will be broken.

Spotlight on event stocks: Here is a stock screen I designed to pick out potential “event” stocks, both Bullish and Bearish. Sometimes, stocks with large changes in price and volume are revealed to be deal stocks, sooner or later, or are the subject of some other extraordinary events, positive or negative.

Bullish Stocks: Rising Price and Rising Volume
% Price Change, Symbol, Name

5.10% , DXD , Short 200% Dow 30 PS, DXD
1.92% , ABI , Applera Corp-Applied Biosystems Group (ABI)
4.85% , MZZ , Short 200% MidCap 400 PS, MZZ
6.11% , QID , Short 200% QQQ PS, QID
2.60% , MCHP , Microchip Technology Incorporated
10.67% , PWER , POWER ONE
1.82% , MYY , Short 100% MidCap 400, MYY
5.88% , SDS , Short 200% S&P 500 PS, SDS
3.56% , MU , MICRON TECH
1.56% , ALTR , ALTERA
2.57% , DOG , Short 100% Dow 30, DOG
1.18% , NVDA , NVIDIA
1.75% , WAG , WALGREEN
0.29% , SHY , Bond, 1-3 Year Treasury, SHY
3.11% , MLNM , Millennium Pharmaceuticals Inc
0.68% , MON , MONSANTO
1.29% , ADBE , ADOBE SYS
0.32% , TIP , Bond, TIPS, TIP
1.25% , LEN , Lennar Corp. (LEN)
0.47% , KSS , KOHLS
0.35% , CHRW.O , CH Robinson Worldwide Inc, CHRWD
0.35% , FAST , Fastenal Company
0.08% , SNPS , Synopsys Inc
0.38% , SO , SOUTHERN
0.15% , NIHD , NII Holdings, Inc.

Bearish Stocks: Falling Price and Rising Volume
% Price Change, Symbol, Name

-2.51% , IWV , LargeCap Blend Russell 3000, IWV
-2.33% , FEU , Value LargeCap Euro STOXX 50 DJ, FEU
-2.88% , PEJ , Leisure & Entertainment, PEJ
-1.98% , EWK , Belgium Index, EWK
-8.49% , X , US STEEL CORP
-6.81% , UST , UST
-3.52% , SLV , Silver Trust iS, SLV
-2.48% , IVW , Growth S&P 500/BARRA, IVW
-1.63% , EWD , Sweden Index, EWD
-4.15% , VWO , Emerging VIPERs, VWO
-4.48% , PWC , LargeCap Blend Dynamic PS, PWC
-4.42% , PWP , Value MidCap Dynamic PS, PWP
-11.78% , SNA , SNAP ON
-6.32% , INTU , INTUIT
-3.20% , IVE , Value S&P 500 B, IVE
-3.42% , RYAAY , Ryanair Holdings plc
-6.73% , A , AGILENT TECH
-7.68% , ETN , EATON
-2.81% , EWG , Germany Index, EWG
-12.21% , CAR , Avis Budget Group, Inc. (CAR)
-1.36% , EWQ , France Index, EWQ
-4.79% , NKE , NIKE STK B
-3.01% , EWC , Canada Index, EWC
-5.29% , BC , BRUNSWICK
-4.50% , VIA , VIACOM INC. (New)
-8.78% , CMI , CUMMINS
-7.47% , DLTR , Dollar Tree Stores Inc
-3.78% , IYG , Financial Services DJ, IYG
-2.49% , IYC , Consumer Cyclical DJ, IYC
-3.53% , IYF , Financial DJ US, IYF
-7.17% , MAS , MASCO
-6.10% , TNB , THOMAS & BETTS
-3.93% , EWM , Malaysia Index, EWM
-3.20% , IAH , Internet Architecture H, IAH
-2.98% , IVV , S&P 500 iS LargeCap Blend, IVV
-2.38% , IYZ , Telecom DJ US, IYZ
-5.38% , YUM , YUM BRANDS
-2.42% , UTH , Utilities H, UTH
-4.80% , VIA.B , VIACOM STK B
-2.58% , IOO , Global 100, IOO
-2.91% , IWB , LargeCap 1000 R, IWB
-4.99% , QLD , Ultra QQQ Double, QLD

Sectors: among the 9 major U.S. sectors, all 9 fell.
Major Sectors Ranked for the Day
% Price Change, Sector

-1.80% Consumer Staples
-2.29% Technology
-2.35% Health Care
-2.67% Industrial
-2.67% Utilities
-2.82% Consumer Discretionary
-2.85% Materials
-2.87% Energy
-3.60% Financial

Looking beyond the daily fluctuation to the major trends (listed in order of relative strength):

Industrial (XLI) Bullish. Price fell to a new 6-week low but relative strength rose. Relative strength made a new high on 8/3/07. XLI has been relatively strong compared to the S&P since 8/9/06. Overweight.

Energy (XLE) Bullish. Relative strength outperformed over the past 3 days after suffering a short-term downward correction from its peak on 7/25/07 to its low on 8/6/07. Longer term, XLE is still in an uptrend compared to the S&P since 3/12/03. Overweight.

Technology (XLK) Bullish. XLK appears to be consolidating since the price peak on 7/19/07. Longer term, XLK has been relatively strong compared to the S&P since its low on 7/24/06. Overweight.

Materials (XLB) Bullish. Relative strength suffered a short-term downward correction from its peak on 7/18/07 to 8/7/07. But longer term, XLB has been relatively strong compared to the S&P since 9/27/00. Overweight.

Consumer Staples (XLP) Improving. Relative strength made a new 4-month high on 8/9/07. XLP has been relatively weak compared to the S&P since 10/9/02. Market weight.

Utilities (XLU) Improving. Relative strength has been rising since 7/30/07. Market weight.

Health Care (XLV) Bearish. Relative strength made a new 5-year low on 7/19/07, confirming a major downtrend. Underweight.

Consumer Discretionary (XLY) Bearish. Price made a new 9-month low on 8/6/07. Relative strength made a new 11-month low on 8/8/07. Underweight.

Financial (XLF) Bearish. Price fell to a new 12-month low on 8/6/07, confirming a major downtrend. Relative strength made a new 6-year low on 8/3/07. Major trends are down. Underweight.

Foreign stocks outperformed for the day and since 7/26/07. The long-term trend is still Bullish: EFA (the EAFE, international developed country stock markets, ex the U.S. and Canada) has outperformed the S&P 500 since 3/19/03.

NASDAQ relative strength jumped to a new 15-month high. NASDAQ outperformed since 5/17/07. This appears to be a significant improvement.

Growth sharply outperformed Value since 5/16/07. Longer term, the major trend of Growth/Value, mostly Bearish for seven years, appears to have turned Bullish.

Large Caps beat Small Caps since 4/19/06, and that trend in is motion. Relative Strength of Large/Small Caps made a new 2-year high on 8/6/07.

Crude Oil prices fell to a new five-week low. But the longer-term trend is Bullish. Crude made a new 10-month price high on 7/31/07. The U.S. OIL FUND ETF (AMEX: USO) remains in its uptrend since its shakeout low at 42.56 on 1/18/07.

Energy stocks outperformed both USO and SPY. Long term, since 3/12/03, the stocks in the Energy Select Sector SPDR ETF (XLE) have significantly outperformed crude oil as a commodity, as well as the S&P 500. So, the Relative Strength major trend is Bullish for the energy stocks.

Gold fell steeply, offering no port in the financial storm. Longer term, StreetTRACKS Gold Trust ETF (NYSE: GLD) has underperformed the S&P since the GLD top on 5/12/06.

Silver has substantially underperformed Gold since 6/5/07. Longer term, iShares Silver Trust (AMEX: SLV) broke down to a new 6-month low on 6/26/07 and underperformed GLD since 12/7/06. So, the main trend is relatively Bearish.

The Gold Miners Index (XAU) underperformed Gold for the day and since 7/19/07. XAU also underperformed Gold since 1/31/06. In fact, Gold mining stocks have substantially underperformed both Gold and the S&P 500 for more than 20 years.

Deflating: inflation expectations falling again. The ratio of the price of bond TIPS to 10-year U.S. Treasury Notes has been falling since 6/22/07, indicating declining inflation expectations.

U.S. Treasury Bond prices rose only moderately and on lower volume. The upmove was less than might be expected assuming a shift from risk to safety. Since the price peak at 97.66 on 6/16/03, the long-term trend appears Bearish for iShares Lehman 20+ Year U.S. Treasury Bond ETF (AMEX: TLT).

U.S. dollar reversed to the upside. The short-term, day-to-day price action is too choppy to call. Longer term, the dollar fell to a new 15-year price low on 7/24/07, confirming the major trend as Bearish.

Daily Rankings of Major Global Markets, Ranked from Strongest to Weakest of the Day:

1.28% Japanese Yen
0.58% US Dollar Index
0.20% 30Y T-Bond
0.00% Airlines
-0.01% Swiss Franc
-0.32% Italy
-0.44% Spain
-0.56% REITs
-0.62% British Pound
-0.66% Semiconductors
-0.81% Euro Index
-0.87% Canadian Dollar
-1.07% Switzerland
-1.17% Biotechs
-1.17% Hospitals
-1.36% Russell 2000
-1.36% France
-1.38% S&P Small Caps
-1.40% Australian Dollar
-1.60% Japan
-1.63% Sweden
-1.69% AMEX Composite
-1.73% Netherlands
-1.79% United Kingdom
-1.80% Consumer Staples
-1.98% Belgium
-2.01% Disk Drives
-2.14% Dow Transports
-2.15% Health Care Products
-2.16% Nasdaq Composite
-2.25% Value Line
-2.27% Chemicals
-2.29% S&P Mid Caps
-2.29% Technology
-2.30% Internet
-2.30% DOT
-2.30% Drugs
-2.35% Health Care
-2.48% Health Care
-2.48% Network
-2.55% Nasdaq 100
-2.59% Dow Composite
-2.67% Industrial
-2.67% Utilities
-2.68% Dow Utilities
-2.70% Wilshire 5000
-2.72% Computer Tech
-2.76% Russell 3000
-2.81% Germany
-2.82% Consumer Discretionary
-2.83% Dow Industrial
-2.85% Materials
-2.85% Insurance
-2.87% Energy
-2.88% Russell 1000
-2.88% Oil Services
-2.91% Gold Mining
-2.92% Austria
-2.96% S&P 500
-3.01% Canada
-3.05% NYSE Composite
-3.10% Natural Gas
-3.11% Commodity Related
-3.17% S&P 100
-3.33% Hardware
-3.37% Oil
-3.60% Financial
-3.66% Broker Dealers
-3.76% Singapore
-3.80% Retailers
-3.82% Taiwan
-3.93% Malaysia
-3.95% Banks
-4.21% Australia
-4.22% Mexico
-4.45% Hong Kong
-4.73% Paper
-4.85% South Korea
-5.26% Brazil

To sum up the current position of the U.S. stock market:

Looking beyond the recent short-term downside shakeout, longer term, the U.S. stock market has shown impressive Bullish resilience since the major low on 10/10/02, more than four years ago. Stock prices have been buoyed by abundant global liquidly (following years of fiscal stimulation, rapid money supply growth, and rising corporate profits), M&A, and earnings comparisons above expectations.

Liquidity driven merger and acquisitions news has been helping to keep the old Bull alive. Both U.S. and foreign corporations hold excess cash after several years of rising profits, and so M&A speculation as well as leveraged buyouts and corporate stock buybacks have provided substantial Bullish stimulus to stock prices. In 2007, mergers and acquisitions are running about 60% ahead of 2006’s record pace, driven by rising stock prices and private-equity funds that raised more than $250 billion for takeovers since the start of 2006. Takeovers are on track to surpass 2006’s all-time high of $3.49 trillion, according to data compiled by Bloomberg.

Conservative earnings estimates also have been useful in keeping the old Bull alive. First quarter 2007 corporate earnings reflected a significant growth slowdown. Nevertheless, earnings were ahead of expectations, which had been lowered to very conservative levels in advance of actual reporting. Managements and Wall Street have learned that investors hate disappointments, so they simply don’t give them any–unless absolutely necessary.

Investors might perceive anything that threatens to end abundant global liquidly, M&A, leveraged buyouts, corporate stock buybacks, and the net balance of positive earnings surprises as threats to the popular Bullish scenario.

Stocks generally are fully valued to over priced by long-term historical standards. Although that alone does not mean that stocks cannot continue to trend higher (as they have the great majority of the time since 2003) nevertheless, it is good to remember that “no tree grows to the sky.” The cyclical nature of stock prices never really changes, although the turning points are not always easy to predict.