The “Stealthy Market Crash”

• The “stealthy market crash” and the two reasons behind it

• Market looking for an excuse to fall, finds it… Sarnoff and Amoss on where we go from here

• BP fulfills forecast seen in The 5… Byron King on the real reason the dividend was suspended

• Reader inquires about African opportunities… Chris Mayer with some pointers

“Last week,” says Byron King, “I met with an economist who specializes in tax law. He claims that we’re in the midst of a ‘stealthy market crash,’ despite the Dow 10,000 numbers.”

“He said, ‘It’s like an Air Force bomber that you can’t see on radar. But if you’re standing under the flight path, you hear the engines. And then you get blown up by the bombs.’”

The gentleman sees two bombs falling. We’ll get to what they are in a moment. First, let’s step back and survey the market territory.

  The Dow zoomed up 214 points on Tuesday for no obvious reason… and on fairly thin volume. Then the market went nowhere yesterday. And it drifted some more on the open this morning.

There was relief at the news of a 0.2% drop in the consumer price index last month — the third consecutive drop. (That means no pressure on the Fed to raise interest rates, and a continuation of EZ credit.) But that was offset by another one of those “unexpected” increases in first-time jobless claims.

In other words, it’s a market just looking for bad news. Which came a half-hour after the open.

  The Philadelphia Fed’s business activity index for the mid-Atlantic region plunged from 21.4 in May to 8 in June. Anything above zero indicates growth is still in place, but this sent the Dow down 70 points… where it still sits as we write.

  Another disappointment comes with the leading economic indicators from the Conference Board. It indicates the recovery dating to April 2009 is still in place… but barely.

Even a slight drop in last month’s report that was revised to a flat reading wasn’t enough to mitigate for a “less-than-expected” increase.

 Nor is it helping itchy traders that options expiration is tomorrow – and a “quadruple witching” at that, affecting futures and options on both stocks and stock indexes.

Still… stepping back from the hour-to-hour noise, it’s apparent we have a market looking soft, no matter whether you look at it from a fundamental or a technical viewpoint.

  “Tuesday’s stock market rally has some convinced we’re off on an enormous new bull run,” says Options Hotline editor Steve Sarnoff, carefully eyeing his charts. “Over the next couple weeks, we shall see if that is so or if buyers are just huff and puff. The bigger technical picture shows stock indexes are weaker than they appear.”

(If you want to be positioned for whatever the market throws at you in the weeks ahead, you can grab a membership to Options Hotline at a substantial discount from the regular fee — but only through this coming Monday.)

“Market internals remain bearish,” says Dan Amoss, assessing things from his fundamental perch. “The rush to cut portfolio risk remains intact. Here is a two-year chart of the S&P 500 (in red) and the iShares High-Yield Corporate Bond ETF (HYG):”

“Both lines in the chart reflect investors’ risk appetite. Over the past year, retail investors have been piling into corporate bond funds. This inflow helped push bond prices up and yields down, allowing heavily indebted companies to refinance bank debt with proceeds from corporate bond offerings.”

“Lots of credit risk has shifted from the banking system to the bond market, where we have transparent, tick-by-tick pricing of credit (as opposed to ‘mark-to-myth’ accounting of bank loans).”

“The return of risk aversion will drive many investors toward higher-quality bonds (away from ‘junkier’ funds like HYG with higher yields and higher credit risk). This isn’t good for leveraged companies that rely on access to easy financing in the bond market.”

Dan has a handful of suitable plays in Strategic Short Report. His new recommendation comes out tomorrow, with a potential 40% gain if you play it conservatively — and maybe triple if you’re comfortable with more risk. You can evaluate it for just $1. After tomorrow, this offer is off the table.

  So why the bearishness? This gets us back to Byron’s economist friend, and those two bombs looming over the economy. They are, as Byron describes it, “the impending expiration of the Bush-era tax cuts, at the end of 2010. By default, there will be an overall tax increase in 2011. That, and there are myriad new taxes in the recently passed health care ‘reform’ bill.”

“With all the new taxes in 2011,” says the economist who shall remain nameless, “the middle class will see its overall tax bite go up by at least 3-5%. Next year, the upper income households in the U.S. will take a new tax hit in the range of 10%, and more. It’s going to be ugly. People don’t seem to grasp that their passive income is subject to higher taxes.

“They’ll scream when they see their pay stubs, or when the accountant gives them their quarterly withholding schedules. When people calculate their 2011 tax bill? They’ll be furious. Then spending will shut down. It’ll freeze. Small businesses will lay people off. The economy will fall off a cliff — It’ll be like the crash of November 2008 all over again.”

  With stocks down this morning, hot money is flooding into gold. The spot price has shot up $16, to $1,247.

  Sales of fractional U.S. Gold Eagles have been brisk since they went on sale a week ago today. The U.S. Mint reports 310,000 coins sold in the first five days, totaling 48,500 ounces.

That’s a slower pace than last year… but last year was a doozy. That’s because the Mint was overwhelmed by demand for 1-ounce Eagles and held off issuing the fractionals till December, unleashing huge pent-up demand. Also, the Mint is strictly rationing the coins to its authorized buyers this time.

Usually this year, a gold rally has also meant a dollar rally. Not today: The dollar index has slipped below 86, thanks to a strengthening euro. The euro has firmed to $1.236 as fears about Spanish banks have abated. For now, anyway.

  The number of U.S banks missing their quarterly repayments to TARP has grown for the third straight quarter: 91 banks out of 600 participants in the program failed to cut a check to the Treasury in time for the May 17 deadline, according to data crunched by SNL Financial.

Twenty-three of those banks missed a payment for the first time. For 20 others, it’s at least the fourth missed payment since the program launched in late 2008.

  BP has suspended dividend payments for the second and third quarters. The board also cancelled the Q1 dividend payout that was due shareholders next Monday.

This should come as no surprise to readers of The 5. On May 26, Byron King declared here…

“It would be unseemly for BP to be paying large dividends at the same time that it’s also diverting funds to well control and cleanup costs, not to mention handling damage claims. The dividend is no longer safe, in my view.”

Today, Byron points out the entire first quarter preceded the Deepwater Horizon blowout. He adds, “BP has the funds to pay that first-quarter dividend. Just not the political cojones.”

BP chief Tony Hayward has ventured to Capitol Hill today, and the PBS NewsHour has asked Byron to “live blog” the proceedings at the program’s website. You can follow the blow-by-blow here.

 Matt Simmons, investment banker to the oil industry, is making a hasty exit from the firm he founded.

Around the same time as yesterday’s issue hit your inbox, Simmons & Co. issued a news release saying Mr. Simmons will retire as chairman emeritus at the end of the month. It was in yesterday’s issue we highlighted his call that BP is headed for Chapter 11… even as his firm issued a “buy” on BP.

Make it two for two with Byron, who posed the question, “What DOES Matt Simmons know?”

“We’ll still see Matt around,” Byron tells us in a follow-up email — “just not with the resources of his company backing him up.” Simmons will now devote his attention to schemes to use wind power off the coast of Maine to generate electricity, turn seawater into drinking water and create liquid ammonia for motor fuel… all at the same time.

“Enjoy your comments and articles,” a reader writes graciously. “Could you possibly give us some insight into the emerging markets and international interest in African investments?”

The 5: A well-timed inquiry, since Chris Mayer has a brief write-up in the current Mayer’s Special Situations.

“Sub-Saharan Africa enjoyed economic growth of 4% last year,” he writes. “It could top 6% this year as the investment dollars flow in from abroad. China, in particular, has looked to Africa to meet its growing appetite for commodities. Trade has increased fivefold since 2003.”

According to the Financial Times, “Africa has 10% of global oil reserves, probably more. South Africa has 40% of the world’s gold. The continent has more than a third of cobalt reserves and base metals abound. Its agricultural potential is barely touched.”

Africa is also a beneficiary of the talk in Australia about a 40% surtax on miners. “Mining firms started to change their plans,” Chris explains. “Suddenly, those projects in Australia look less attractive. Where do they go? At least a healthy percentage increased their plans in Africa.”

You can see Chris’s full report — including an intriguing speculation with a near-term catalyst — in the current Mayer’s Special Situations, available for just $1. Sign up today and you’ll also get eight China-themed plays gleaned from the trip he and Addison made to China last month. It includes two firms working in Africa to feed the Middle Kingdom’s insatiable need for energy. Grab this unbeatable bargain here.

  A reader writes after seeing the news that Bill Gates and Warren Buffett are challenging their fellow billionaires to pledge 50% of their assets to charity, if not now, then in the hereafter: “Instead of encouraging billionaires to give away the store, Gates and Buffett should put their money with entrepreneurs who have job-building companies they want to start. Ayn Rand would have had a fit of dyspepsia to hear such garbage.

“Of course, billions can be used to sop up the squander of the welfare whiners. Once it’s gone, it may gone forever. Someone needs to remind Buffett that he is departing from his successful principle of not paying dividends in order to build companies and achieve higher good.

“Unfortunately, Buffett is listening to the socialists in our country, instead of his own head. It’s true that both men will be lauded for how nice they are while the ‘intellectuals’ will be laughing at them behind their backs calling them ‘stupid.’ Don’t these two men know the people they are listening to think people who work and make money are bad people? These ‘elites’ have no honor and would love the opportunity to squander these enormous funds to their lazy malcontents and nonproducers. These two men need to keep their money out of the hands of the do-gooders and use it to build our country’s industries.”

The 5: So what say you? Are Gates and Buffett onto something or are they losing it? Sound off here.

Regards,

Dave Gonigam

The 5 Min. Forecast

P.S. In case you gave today’s issue only a cursory read, let’s connect a couple of dots here. You can secure access to two of our high-end services today for just $2.

You get Chris Mayer’s write-up from his China visit — complete with eight recommendations — with a trial membership in Mayer’s Special Situations, available for $1 here. And you get a trial membership in Strategic Short Report, with Dan Amoss’ new recommendation coming out tomorrow — also for just $1.