Merrill Lynch Strikes Out

We noted in our last update that the market appeared to have found a short-term bottom. Despite significant intraday volatility, the S&P 500 has managed to close above support each day this week. Even more encouraging is that the benchmarks have held more or less steady in the face of several bearish events. Consider the following:

First, Wall Street icon Merrill Lynch (MER) revealed major mortgage-related trading losses in its 3Q report. $8.4 billion is a lot of money even to Merrill Lynch, and was a huge surprise since only two weeks ago the company had estimated its losses would be about $5 billion. The numbers themselves are less important than the fact that no one seems able to pin down exactly how big their losses are - or will be in the future. If it can happen to Merrill, it can happen to anyone. Today insurance giant American International Group (AIG) was hit with rumors of similar problems. The company issued a denial but AIG stock still plunged.

Second, crude oil prices moved up to a new record today, erasing several days of weakness. New tensions in the Middle East and a sharp drop in U.S. oil inventories drove prices higher, and the $100 mark is looking closer and closer. For now at least, supply concerns in the energy market are overwhelming the possibility that economic weakness will lead to a drop in consumption.

Third, the Federal Reserve meets next Wednesday and now seems nearly certain to cut interest rates in response to the market and economic turmoil. Whether it will have the desired effect won't be known for months, but lower rates will definitely lead to further dollar weakness. To the extent U.S. companies earn revenue overseas, this could be helpful in the short-term. The long-run impact is much harder to discern.

The net of all this is that the bifurcated market seems likely to continue. Financials, real estate and consumer discretionary stocks will stay weak while technology, energy and materials remain the upside leaders.