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In our early morning pre-jobs report commentary we said that "recent economic data tilts the odds in favor of a strong employment report this morning". Like many others throughout the land, our expectations were soon proven to be slightly off base as the report which so many had waited on pins and needles for all week came in significantly below expectations.

Average hourly earnings , the number we said to watch, surprised on the downside with a meagerly gain of 0.2%. Non farm payrolls, that most watched of numbers, registered a surprisingly small gain of 124,000 jobs, compared to expectations of a 220,000 rise. The unemployment rate provided the only black spot, but it was an expected black spot, as the rate dipped to 4.2%.

This morning we said, "We expect the stock market to rally if the numbers come in as forecast, or below forecast. Keep in mind that with the Dow still above its critical support level of 10,450 that there is still enough complacency floating around to spark a rally at the drop of a hat".

Well, the hat was dropped, and the market did rally as expected, but is the current rally justified, has today's report changed the future scenario for interest rates, will the Pre-emptive Crusader put his costume in storage?

We think not.

As we said this morning (when we expected an upside surprise), "...we would caution against taking today's employment numbers in isolation. While there is an increasing tendency to regard each bit of economic data as "the definitive report" that will sway the Fed, the reality is no one bit of economic data holds the magical answer to the Fed's next move. Each economic report must be evaluated in the context of the broader knowledge base of economic data that has preceded it."

Today's report, benign and inflation free as it was, closely followed a string of strong economic reports that have been released over the past week that indicated that the economy remains strong, the consumer happy, and the labor market tight.

Today's report , despite the below forecast showing by non farm payrolls, on closer examination shows that third quarter job creation is running marginally above trend at 231,000 versus the 12 month average of 228,000. It also should be remembered that the non farm payroll number is a volatile creature, May's numbers also provided a pleasant surprise, one which was quickly erased in subsequent months. The recent strength shown in the durable goods numbers and the NAPM

So, while today's numbers came in below expectations, we do not believe that the question surrounding the future direction of interest rates has been resolved with their release.

While there are many central bankers who have no problem with doing a monetary policy flip based on one indicator, and their economies are the worse for the wear because of it, we give the Federal Reserve a little more credit.

After enjoying a momentary relief rally lapse from the jitters of rate policy uncertainty, we expect the market to quickly return to its recent path of living economic release to economic release.

 On the interest rate front, the questions of when, if, and by how much have not been answered by today's report.  In short, the jury remains out pending further evidence.

While the news from Sears was grim, the slowdown at Sears remains an isolated event and is not symptomatic of a widespread slowdown in the land of retailing.  Today's same store retail sales figures continued to show strong consumer spending, and until Wall Street's current econojitteritis spreads to Main Street, the consumer will continue to flock to the mall.  When the jitters do spread to Main Street, however, the retail stocks are likely to resemble a skydiver without a parachute.

The continued strength in the retail sector, more specifically the resiliency of consumer spending in the face of an adverse interest rate environment, remains one of the main impediments to the stock market regaining its Spring lustre.  We say one of the main impediments, because there are others, one of which is the suddenly rejuvenated manufacturing sector.

Today's Factory Orders report added further confirmation to the strength shown by the recent durable goods and NAPM surveys, as orders rose a stronger than expected 2.1%.

While the consumer, and now the manufacturer, continue to power the U.S. economy along a strong growth path, the secret weapon in Goldilocks makeup case of longevity enhancers continues to come under pressure: the (once upon a time) factor of rising productivity.

Today's revised second quarter productivity numbers were not a pretty sight.  Productivity was revised down to 0.6% from the previously reported 1.3%, while unit labor costs rose a revised 4.5%, their steepest rate of ascent since early 1994.  Add rising labor costs, and lower productivity, to a tight labor market, and those inflationary pressures bubbling under the surface look that much closer to seeing their first glimpse of daylight in many a year.

No mention of the word inflationary would be complete, of course, without first mentioning the dollar, which continues its descent, sitting on support at 99.22 and balancing just above 109 yen to the dollar.

When inflation jitters start to simmer, all eyes turn towards the Fed, and today those eyes alit on a hawkish figure who spoke a hawkish tongue.

This morning's rise has convinced many that a bottom is at hand, that the market's recent "misguided" focus on the archaic notion of pass� economic principals and intermarket relationships  has drawn to a close, that the focus can now return to what drives the market: Internet stocks and the NASDAQ 100 tech stocks.

This morning we too must admit we are decidedly bullish, for it is a bullish time: bullish for those who bet on a bottom being in place in the CRB, bullish for those of us who grew weary of 7 months of picking on the euro and decided that circumstances had made the dollar fairer game, bullish for those who placed their bets on growth in Japan and Europe.

Unfortunately, we're not so sure that the things that have made us outright bulls are necessarily bullish for those who remain convinced that the world spins by the light of the silvery Yahoo moon.  While the Internet stocks may get the press, they remain but mere specks upon the broader financial landscape, the dollars transacted in their name a tiny iota in the world's daily financial ledger when compared to the money that swishes around in the larger fishpond of the currency markets.

With the yen at 109.43 to the dollar this morning and the US Dollar Index at 99.75 and sinking rapidly to support, with the IMF bullish on Japan and the Bundesbank bullish on Europe, it is perhaps time to put aside thoughts of the next leg up in the tech sector, and instead say a few prayers that a miracle will materialize to end the dollar's slide.  For it is perhaps only prayers at this point that will do the trick, because the hoped for intervention, if it should occur, will not provide the cure. Central bank currency intervention, while providing a short term temporary reversal of fortune, in the end is powerless to halt the slide of an out of favor currency.

Over the next few days we would watch 99.1 on the US dollar Index closely. The level of the dollar, however, is not the only number that bears watching as the month commences.  On the upside we would keep a close eye on 200-201 on the CRB, with a move above spelling double trouble for the bond market.  On the downside a plethora of support levels await the eyes of the observer: 3050 on the Dow Transports, 1725-1733 on the NASDAQ Bank Index (see today's market chart). For midcap and smallcap fans, as mentioned in yesterday's market chart, the key levels to watch remain 384.7 on the SP MidCap 400 and 173.35 on the SP SmallCap 600.

This complacency, in the short term, provides the market with a safety net--a steady stream of players willing to throw their money at a  trend that, as we said yesterday, for the broader market has already passed (with 53% of stocks now below their 200 day moving average) . While providing the large cap and glamour issues with a temporary safety net, this continued complacency in the face of a changed environment is merely history's way of repeating itself. 

While we have heard pundits continue to voice their opinion that history has changed, that the emergence of the Internet has negated the previous rules of market history, that decades of economic research have been negated by a new era, we continue to see nothing new.

Instead, we see history repeating itself with a vengeance.  The market continues to display all the signs that historically have signaled a top. The market's increasingly narrow breadth, and diminished volume over the past months continues to spell trouble.  As a trend reaches its final end, it is the last in who are typically the last out.  We are seeing that now as investors have increasingly flocked to a select group of well known issues, while the broader market slowly sinks, a pattern that has been repeated ad nauseum in the past. 

The presence and continued faith in the recent trend (despite a changed environment) by the self-described new breed of "traders", emboldened by having ridden on a steeply rising trend (a feat which speaks not of trading skill, but rather of having discovered the stock market at a fortuitous time), is yet another historical sign of a market top.  At every market top we have seen a similar upsurge in the number of "traders" who feel they have discovered the key to an easy life in the markets (and in every decline we have seen their ranks quickly thinned as reality sets in). 

While faith continues to exist, the odds of that faith achieving its goals (of perpetual 30% returns) continue to decline rapidly. On the nuts and bolts fundamental side of the street, the circumstances that made the outsized returns of recent years possible have now changed, and in many cases reversed dramatically.

 From a technical perspective, the market can only be described as sick. The extreme divergence between the narrow strata of "people's choice" stocks and the broader market can not be ignored.  In the coming days we would keep a close eye on the S&P Midcap 400 and S&P SmallCap 600 indexes, both of which, as today's market chart shows, are on the verge of confirming head and shoulders tops.  Moves below 384.7 on the SP400 and 173.35 on the SP600 would confirm the tops, and would be a strong signal to "abandon ship" on mid cap and small cap issues.

The Fed's initial success in preventing a euphoric spike in the major averages last week in no way ensures that they will be successful in their ultimate aim of bringing the economy in for a second soft landing before the bubbling undercurrent of economic imbalances erupts to the surface.

In order to succeed in their mission, the Fed will need the stock market to show the same ability to learn from its mistakes that the Fed has shown.  At this point, despite a surface veneer of fear and restraint in last week's closing days, the stock market is still lagging in its ability to learn from past errors.  Underneath the jitter infested surface, the market's unrelenting complacency remains intact, ready to propel shares to new heights of historical valuation excess at the drop of a hat.

It is this deeply ingrained layer of faith in the sustainability of the trends and returns of the recent past, and its accompanying disregard for risk and ignorance of market history, that will likely prevent the Fed from reigning in the economy without a considerable amount of (financial) bloodshed first occurring. 

When beliefs become deeply entrenched at an extreme, they are not easily dislodged. Their return path to historical norms does not occur with a gradual nudging, but rather it is accomplished only by the unexpected shock.  The investor who has seen a 50% gain in his 401k portfolio of large cap growth stocks since last October's lows will not be deterred by a 1/2% rise in rates--a rise whose psychological effect on the investor pales in comparison to the mental (and monetary) boost that this decade's soaring equity prices have produced.

As the summer enters its final week, and fall beckons around the corner, preservation of capital rather than shooting for the fences is the order of the day.

 To the untrained eye with myopic vision, the path ahead may still seem to be paved with gold.  The surface landscape is still untarnished, from a strong economy to a low inflation environment, from a Dow and NASDAQ still within striking distance of their old highs to a return to health of the global economy, the signs of a golden era remain.

To the trained eye, the present environment is more fraught with danger than reward, and the tides of fortune have already begun to turn.  While the surface still glistens, the underlying supports have begun to quake.  From an unfavorable interest rate environment to a reversal of the flow of foreign funds, from a weakening dollar to a reversal of trend by commodities, from the major averages near record highs to a sinking broader market, the warning signs abound.

As the changing of the seasons nears, the best success will be enjoyed by those who heed the time tested maxim "the trend is your friend".  With 51% of stocks now trading below their 200 day moving average, 57% below their 100 day moving average, 62% below their 50 day moving average, and 54% below their 20 day moving average, the broader market trend is now clearly down. 

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