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Bulls, Bears In Tug Of War

The market has been engaged in an interesting tug-of-war the last two days.

On one hand is the first genuinely hopeful manufacturing data since the economy fell off a cliff last November.

And on the other is a few weeks of data suggesting that consumer spending may be weakening.

Strong rallies have collapsed two days in a row on that dichotomy, and with good reason. Consumer spending is two-thirds of the economy, and a strong rebound in manufacturing is unlikely if the consumer begins to reign in spending.

But yesterday's NAPM data was unmistakably hopeful. Manufacturing still contracted in August, but at a much slower pace than it had been. And production and orders both rose for the first time this year. However, it takes a few months of data to establish a trend, so the NAPM data needs to be followed by strong reports for September and October.

But last week, two different surveys showed consumer confidence beginning to wane. And personal income grew much faster than personal spending, which posted its smallest gain since last October. Retail sales have been flat for three straight months. Continued erosion in consumer confidence and spending would neutralize any rebound in manufacturing, and could very well tip the economy into recession. And that's why strong rallies faded the last two days.

The consumer has been the only thing holding up this economy since late last year. For the last month, since the Fed beige book report showed weakening consumer resolve on August 8, the market has been pricing in a decline in consumer confidence and spending. Where that level will ultimately be is anyone's guess, but with the market continually consolidating at the lows, a retest of the April 4 lows appears to be a given at this point. A strong rebound off those levels (1080-1100 on the S&P, 9100-9400 on the Dow, and 1619-1639 on the Nasdaq) would be a sign that the market has done enough correcting for now.

The good news is that in the short term, the Nasdaq is oversold enough to produce a fairly reliable bounce in the next day or two. But until those April lows are retested, that bounce is more likely than not to be short-lived.

But the worrisome thing is that we have yet to see sentiment indicators give signs that sellers are washed out. Commercial futures traders, the so-called "smart money," remain short the S&P and Nasdaq futures, while small investors remain long the Nasdaq futures. At major bottoms, the opposite is usually the case, with commercials long and non-commercials short. The Investors Intelligence survey continues to show much more bullish sentiment than bearish sentiment; bulls and bears were even at the April bottom, and at major bottoms bears usually exceed bulls. Wall Street analysts remain far too bullish in their equity allocations, which are currently at around 70%; in October 1998, they briefly dipped under 50%. All those longer-term indicators imply that this bear market may continue to grind on for a while.