Recently there has been numerous media reports regarding a potential tie-up between CME’s Dow Jones index business and Standard & Poor’s. To date there has been nothing official but what initially caught my eye was a Reuters’ story that attributed a sharp drop in Chicago Board Options Exchange (CBOE) stock to the potential merger. CBOE has exclusive licenses to list equity options products with both Dow Jones and S&P. In fact, CME and CBOE have sparred in court in the past over the nature of their separate licenses with S&P. The idea put forward in the story was that CBOE’s exclusive license agreements with the two companies could be threatened if there were some type of agreement.

Since, CBOE leadership has said that a Dow/S&P tie-up would not be a threat because they have agreements going out to 2018.

What I don’t understand is that in none of the speculation regarding the whole matter has the idea of the Department of Justice coming in to look over such a merger between CME’s index business and McGraw Hill’s S&P index business to see if it were kosher. The whole premise behind the Reuters story appears to be prima facie evidence that such a deal would raise antitrust concerns.

The regulatory regime in the equity options world puts a premium on multiple listings and CBOE has had to fight in court to maintain their ability to list certain indexes exclusively. If the two best known index providers merge, the grip of these exclusive licenses would tighten further.

When Russell Indexes chose to enter into an exclusive license with the Intercontinental Exchange (ICE) to offer futures on it popular Russell 2000 index back when the two exchanges were battling over the Chicago Board of Trade, CME turned to S&P to license its similar 400 and 600 indexes as a proxy for the small- and mid-cap space. A merger of two of three major index providers would seem to further limit that type of competitive response.

 I have to admit I found that amusing. You see, I had just posted a chart on our web site indicating how some significant technical support areas had been breached on the Dow Jones Industrial Average. I had been having a conversation with one of our contributors about this and he had indicated earlier in the week that the market could be facing a turning point.

Jeff Greenblatt (aka Fibonacciman) had noted on Monday, “Last week, it appeared we could be setting up for an inversion of the 610 trading day cycle to the March 2009 Haines Bottom. That window kicks in at the end of this week….  I remarked to my client base that we started getting that ‘end of world’ feel to things. It seemed like we were having a smaller version of 2008 all over again. … there has always been and now can’t be ruled out a chance we could have a market top as a result of all this on day 610.”

Actually it looks like the market topped on July 21 when it failed to take out a top from two weeks earlier and began its current slide. A slide that pushed the indexes up against significant trendlines that were subsequently breached. The point being there was some significant technical validation in yesterday’s move.

However what amused me harkens back to Geithner’s nomination. Jeff is an ardent technician who has pointed out in articles in Futures and at numerous conferences, that most important market reversals can be predicted through the study of technicals, more specifically market cycles.

He has pointed out that often we look to the newswires for reasons but even when the reason seems legitimate, like the Lehman Bros. bankruptcy, TARP vote, Japanese tsunami etc. there is a corresponding technical cyclical reason for a major price reversal.

Sometimes the news event seems paramount and at other times it seems a stretch as when in November of 2008 the pundits attributed a market bottom and subsequent rally to President Elect Obama naming Timothy Geithner Treasury Secretary. Really; that is what turned around the market?

At the time, Greenblatt had detected a significant technical top in the U.S. dollar, which he attributed to setting a floor in equities. The dollar and equities have been negatively correlated (look at yesterday’s action) especially in the last decade.

The Geithner story from 2008 illustrated just how silly the business media can be in trying to tie a market move to a particular item in the news. Now yesterday’s story was partly tongue in cheek but I guess it is only fair to blame yesterday’s carnage on the chance Tim Geithner will be staying at Treasury.

The scary thing is just how easily some of us can accept such dubious cause/affect assumptions. I am sure over the weekend you will hear blame being tossed around for what happened in the markets. It was the Tea Party? It was the President. It was the failure to extract deeper budget cuts. It was the cuts.

Perhaps it was technical.

Perhaps some analysts and pundits breathed a big sigh of relief when equities rebounded after a huger sell-off on Wednesday to close higher. No relief was in sight today as the Dow dropped more than 500 points and the S&P 500 dropped 55 pushing both indexes into the red for 2011. 

We see two possible explanations: fundamental and technical. First perhaps investors and the rest of the world where a bit shaken that a significant portion of our elected leaders would take us to the brink of default to prove a point. Basically that they would not be the first to blink.

 How much confidence can you have in an economy with such recklessness in high places going on? We pointed out last week that the debt ceiling debate was having real consequences. People and markets were working in a chance of a default — albeit a slight one — into their risk models. Margins rose and haircuts on Treasuries were increased. That meant funds had to be diverted from other things to cover that small downgrade in collateral.

That being said, the markets did seem a little toppy and last week’s sell-off pushed the indexes to some significant support levels that were taken out. So while you listen to blame get tossed around the next couple of days remember this move may be mostly technical.

More on this shortly.

Newsom sees a long-term sideways trend for the U.S. dollar index and says that the dollar should drift lower this quarter, with a downside target of 81.475. For gold, he says if the Dow comes under pressure, gold could once again be a safe-haven market, and that its fundamentals are neutral to bearish, with the long-term trend up and the short-term trend down. For the short term for gold, Newsom forecasts the next level of support near $1155, then $1117. He says long-term support is near $1073 and may have to be tested to find renewed buying interest.

The same trends are holding for copper, Newsom says, with the long-term trend up and the short-term trend down. As for crude oil, with the structure of the market still bearish, Newsom says it should come under seasonal pressure with initial support near $69 and longer-term at $59.

Add to that an odd consensus between bears and bulls of a significant downturn. Many bears were thinking we were at a historic high and ready for a reversal as the economy is poised for a double dip recession. Many bulls, realizing the market cannot go up forever and seeing that the S&P 500 rallied more than 80% from the March 2009 lows, were expecting a correction, a significant correction of at least 10%.

Now throw in to the mix the problems with Greece and the threat it extends to the other PIIGs (Portugal, Ireland, Italy and Spain) and the Eurozone as a whole. That brings flight to quality buying into the U.S. dollar and Japanese yen, which causes the unwinding of some carry trade positions that may be bankrolling some of these equity positions.

Oh, add to that today is the unemployment report day so many people already expecting a correction may be getting out or tightening stops for fear a bad number could cause a major drop.

And yesterday was a bad day. The S&P 500 was down about 34 points and the Dow about 250 points before things got crazy. There were a lot of people, bulls and bears alike ready to push the sell button.

There are numerous reports that a fat fingered error, involving Procter & Gamble caused the carnage. That may be true. Equity exchanges have busted some of the unusual trades though the CME Group stated “We did not experience technology or systems issues associated with trading activity between 1:00 and 2:00 p.m. CST” and no trades we busted.

What also is true is that is was the worst possible time for such a mistake given all of the factors that had traders on edge and ready to dump.

Even with all of that, the exchanges have to ask what happened to the liquidity. Large liquid markets should not go down that far that fast. In some markets there are participants that are remunerated for providing such liquidity. What happened to those folks as it is obvious, in the parlance of the floor, a lot of market makers put their hands in their pockets.

The move creates problem for technical traders as is the case when an error causes markets to hit extreme levels. How do you treat prices? Whether it was caused by a mistake or not the technical damage is done.

We are curious to know what you think.

However those gains were lost and then some on Friday as the Dow dropped 225 points. And it could have been more than simple buy the rumor sell the fact activity.

John Williams of shadowsstats.com, in his commentary on Thursday wrote, “The general outlook for the U.S. economy continues to be for severe contraction, with the worst still ahead.”

Williams points out that 92% of the third quarter growth can be attributed to one time stimulus programs. Yes that is the whole point of the stimulus but at some point the training wheels must come off and when they do some real economic growth needs to happen.

Williams point out that “All U.S. recessions in the last four decades have had at least one positive quarter-to-quarter GDP reading, followed by renewed downturn.”

He expects that to continue this  time.

While many people at the time felt the market may have been ahead of itself, the overall feeling was one of optimism. In fact, the Dow had corrected more than 20% the year before from its impressive late 1990s run so it appeared that there was clear sailing ahead. These were the days when bears were ignored as being anachronistic and the new paradigm was being touted. Remember? Things like price earnings ratios didn’t matter anymore, a company didn’t need to show profit for its stock to grow exponentially. The Dow was headed to 35,000.

 I am not to sure what the reaction was on the financial floor of CME Group today, now located at the Chicago Board of Trade building. I am guessing it was much more subdued and not just because there are far fewer traders.

While many experts are still pushing equities and this current bull move, these are the experts who missed the 2000-2002 bear market, they are the experts who dismissed the credit crisis and declared it over before it began in earnest. They have said the same thing all along and like a broken clock; they are bound to be right at least twice a day or in this case, twice in a decade.

Equity cheerleaders aside, there is much more caution in the reaction to the current move. Comments on newswires are expressing disbelief and warning of impending doom — perhaps that is a sign this rally is sustainable but I doubt it. We are in a recession, perhaps technically we have grown out of it in the third quarter but the jobs have not come back and the skyrocketing debt has not been paid off.

Perhaps this is just the market adjusting to a weaker dollar as some technicians believe explains the 2007 high. Will Fed Chairman Ben Bernanke call this irrational exuberance? I doubt it. At least in the 1990s the irrational rally didn’t occur in the midst of a recession. One thing is for sure, no one has any excuse for getting caught up this time. We have two examples this decade that the market goes down as well as up and the next one may me more painful than the others.

The market in general also tanked again today, with U.S. stock indexes finishing down 4%. Earlier this week the Dow hit its lowest level since 1997. With market performances like that, it could be time for everyone to start hitting the dollar store. Or the bottle.

The Dow was hovering below 8,000 midday on Feb. 2. Hopefully for the Dow Bill Murray’s weather prediction in the 1993 classic based on today’s holiday (“It’s gonna be cold, it’s gonna be grey, and it’s gonna last you for the rest of your life”) won’t come true.

And, because we know you’re in the mood for it, here’s a clip from “Groundhog Day”:

Groundhog Day