By Jim Donnelly, Olson Global Markets

In front of the release of August’s employment data this Friday, a series of economic reports released over the past two weeks has investors deeply pessimistic once again. As a result, the “run-to-safety” trade into U.S. Treasury securities pushed interest rates (across the yield curve) to new lows before a correction occurred toward the week’s end. Contributing to investor fears was a sense that the Federal Reserve has done most of what it could do, and most of what was expected of it to help nurse the struggling economy back to recovery. This wide-spread appraisal appeared to gel in the wake of last week’s central bank’s conference in Jackson Hole, Wyoming, and despite Fed Chairman Bernanke’s pledge to do even more.

Moreover, mounting pressure now appears to be shifting toward Washington to utilize more fiscal stimuli in front of the elections, a time that is considered too ticklish to get anything accomplished for many an incumbent.

It is no wonder that technical analysts are worried that a bearish “Head & Shoulders” pattern on the Dow Jones Industrial Average could play out to the downside. If it did, it would make investor sentiment even worse, despite last quarter’s better-than-expected earnings reports.

Since most analysts believe a legitimate turn-around in both the stock market and in the economy requires a healthy banking system, a renewed look at the Keefe, Bruyette & Woods U.S. Bank Index (BKX) is in order. With oversold conditions present, it is important to note that the BKX is now approaching a test of two key support areas that are very close to each other. The first is trend line support drawn off the lows since August 7, 2009 that sits at 42.75. The second is “channel bottom” support at 41.75 drawn off a series of highs and lows that date back to March 6, 2009. Although trend line support will change very little over the coming months, it is worth noting that “channel bottom” support does rise over time.

As a result, the 41.75 level holds great importance for the BKX and the overall condition of equity prices over the intermediate-term. If it holds and turns the Keefe, Bruyette & Woods U.S. Bank Index to the upside, a giant sigh of relief should occur for many investors. A solid break below, however, would be a big negative and a major concern.

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By Jim Donnelly, Olson Global Markets

A clear sense of unease, underscored by another stunning flight into U.S. Treasury securities, has engulfed the equity markets. An unexpected 500K jump in initial weekly jobless claims reinforced the notion that that employment picture is far bleaker than previously thought. Adding to this dark economic outlook was a report issued by Fidelity Investments on Friday noting that hardship withdrawals from 401(k) retirement saving plans rose to the highest level in 10 years during the second quarter. Further, Fidelity reported that the percentage of 401(k) participants that had an outstanding loan against their account rose to a record high of 22% during the second quarter, with an average loan amount of $8,650.

With a number of economic observers worried that the Federal Reserve may be “running out of bullets” in the attempt to turn around and sustain an economy recovery, investor confidence has become more unnerved. Renewed fears over Greece as well as concerns over domestic municipal budget woes resurfaced last week as well.

With a backdrop of continued equity fund outflows and an increase in “fixed income” or bond fund inflows, it may be worth noting that the Dow Jones Industrial Average appears to be forming an unusual type of Head & Shoulders pattern that appears very similar to one that developed between 2007 and 2008. In both cases the “neckline” of their respective patterns is characterized by a steep downward sloping pitch. Of course, the current market for the DJIA is 3,000/4,000 points lower than during the 2007/2008 period, which is worthy on note since Head & Shoulder patterns often show up at extremes in the market. While the current market maybe relatively extreme when compared with the March 2009 selloff low, it is not similar to the 2007/2008 buying extreme, which set an all-time high for the DJIA back then.

Nevertheless, “patterns within patterns” technically can often be of a similar nature, akin to having the same sort of DNA in a sense. In this context, the hangover from the fear of an economic meltdown from a few years ago has not yet worn off, either domestically or globally. Memories of that period’s tumult remain fresh in many investors’ minds. Oddly, that may well be a good thing. After all, a lot of selling of equities has already occurred, with “cash on the sidelines” already tucked into extraordinarily low yielding U.S. Treasuries, FDIC insured bank CDs, corporate bonds and notes, gold, silver and, perhaps, into the safety of mattresses! Recently, a few well known hedge fund managers also tossed in the towel and closed up shop.

Although the DJIA may resemble that of 2007/2008 technically, market sentiment is very, very different. Still, equity markets do not like uncertainty which seemingly abounds today. Many changes, including the Health Care Bill and FinReg have decision makers at the business level handcuffed due to the technicalities of implementation. That condition, by itself, will tend to retard job growth. In the end, these kinds of concerns may well force investors to pay heed to the unusual looking “Head & Shoulders” pattern that may be developing now.

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Jim Donnelly, Olson Global Markets

Following a week’s worth of evidence that the economic recovery is sputtering, another leg of the “run-to-safety” shift into U.S. Treasury fixed income securities ensued. A spate of better-than-expected 2nd quarter earnings results took a back seat to a number of troublesome reports.

Initially, The Federal Open Market Committee announced that it would reinvest maturing mortgage-backed securities back into the government debt so that its balance sheet would not shrink. This was seen as a signal that economic activity in the U.S. was losing steam. Then, Cisco System’s Chief Executive John Chambers warned that he was seeing “mixed signals” and an “unusual uncertainty” following lower than expected first quarter sales. Adding to Wall Street jitters was an unexpected rise in weekly initial jobless claims to 484,000, the largest jump since February. Disappointing industrial production numbers in the euro zone worried investors’ confidence further. As a result, U.S Treasury 10-year notes ended the week at a yield of 2.688%, the lowest seen since March 2009.

Technically, the yield on 10-year Treasuries continues to decline within a downwardly sloped “trading channel” that has been in place since 1993. Although, weekly stochastic measures are falling rapidly, they are not yet in an oversold condition on weekly charts. Thus, an opportunity for 10-year yields to test key “cross” trend line support (resistance in terms of price) currently at the $2.40% level is possible.

If the 2.40% yield area fails to hold, however, it is worth noting that “channel bottom” support for 10-year U.S. Treasury yields now sits at $1.72%. Conversely, that would represent key resistance when thinking in terms of 10-year note prices. For this area to be tested, however, an extended period of worrisome news would likely be needed.

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By Jim Donnelly, Olson Global Markets

Although taking some time to develop, the Dow Jones Utility Index (DJU) appears to be setting up for a solid move upward. A bullish “reverse head & shoulders” pattern that has been in the making since the post-Lehman Brothers plunge in October 2008 continues to form, targeting a potential move up to the 525 area.

Fostering this technical viewpoint is an apparent fundamental thirst for yield. Persistent pressures from pension plans, retirees, college endowments and others who rely on interest and dividends for their day-to-day needs are finding low yielding U.S. Treasuries, intermediate-term CD’s and money market accounts extraordinarily stingy.

While a good number of investors continue to tout their preference for the “return of their capital”, rather than “return on the capital”, others are becoming weary of that standpoint. As a result, there is a growing chorus of advisors that point out that many S&P 500 common stocks, including utilities, are paying higher dividend yields than are 10-year U.S. Treasury notes.

Because the balance sheets of most utility companies are typically laden with debt, the worry has been that rising interest rates would not only compete with yields on their common stocks as an investment vehicle, but would also become more costly to them as they routinely refinance their outstanding debt if in a rising rate environment.

Following Friday’s disappointing employment data, as well as Goldman’s Sachs’ forecast for the unemployment rate to inch up to 10% into 2011 and stay there for the remainder of the year, the expectation for interest rates to rise has once again been muted. In addition, a potential decline in interest rates could result in lower debt costs to utility companies, That, in turn, should make those who thirst for yield to take a harder look at utility common stocks.

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By Jim Donnelly, Olson Global Markets

After Federal Reserve Bank of St. Louis President James Bullard noted that the U.S. economy might be getting closer to a Japanese-style outcome hinting that the risks of deflation were rising, yields on U.S. treasury securities declined once again. That said, other observers including Charles Plosser, president of the Philadelphia Fed, said that “I don’t think deflation, or sustained deflation, is a real problem at this point. It is hard to imagine how you can get that when you have got a trillion dollars in excess reserves sitting in the banking system or as long as expectations of inflation are well anchored.”

These viewpoints, as well as many others, underscore how the debate over inflation versus deflation has become more and more a front burner issue. While it is clear that wage pressures are extraordinarily muted at the moment give the employment picture, commodity prices as measured by the Reuters/Jefferies CRB Total Return Index have risen somewhat since the end of May. With that in mind, it is interesting to note that this Index is approaching a test of key trend line resistance now sitting at the 283 level. A break above it, if it occurs, would tend to raise hopes that demand for commodities is strengthening, and in turn hint that final demand and the economy are improving as well.

Nevertheless, the employment numbers due out at the end of this week will be key in sizing up whether employment and wage stability are at risk. Those factors, as well as the direction of commodity prices, are crucial to the “inflation versus deflation” debate.

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