About $1.8 trillion has been erased from American equities as reports on manufacturing and consumer spending showed the world's largest economy is slowing. Forecasters at UBS and Deutsche Bank AG say rising profits mean the S&P 500 deserves a higher price-earnings ratio than the 28-month low reached yesterday. A year ago, strategists also remained bullish after a 14 percent drop, and proved prescient as the S&P 500 rallied 20 percent from its August low.

"I'm reluctant to overreact to some shorter-term weakness, no matter how real it is, because the market has proven to be unbelievably resilient," Jonathan Golub, the chief U.S. market strategist at UBS in New York, said in an Aug. 3 phone interview. "If you would have been acting that way for the last two years, you would have gotten killed by this market. Companies have done an absurdly good job of managing through this environment."

Eoin Treacy's view This article raises the important question whether the current sell-off is comparable to the deterioration experienced last year by most stock markets. From April 2010, QE1 was ending, there were continued worries about the USA's recovery, Greece's troubles were intensifying and a number of Asian countries had begun to raise rates. The announcement of QE2 was a catalyst and stock markets rallied persistently for at least a few months following that event.

Fast forward to 2011 and QE2 has just ended, there are the same worries about how the USA is going to close its fiscal, budgetary and entitlement deficits. The Eurozone's crisis has enveloped Ireland, Portugal and more recently Spain and Italy. Spreads on even French and Belgian bonds are beginning to expand and the Euro's equivalent of the yield curve spread has surged. One clear difference this year as opposed to last year is oil.

Brent Crude prices rallied by more than 50% between October and April and despite medium-term top characteristics have held above $100 since early February. High energy prices act as a tax on consumption and a headwind to growth. It is unreasonable to expect corporations to continue to exceed earnings estimates in the face of slowing economies in the USA and Europe and high energy prices. Lower oil prices are a precondition for a sustainable recovery to take hold. So far Brent crude has reverted towards the 200-day MA but it needs to sustain a move below it to confirm medium-term supply dominance.

This weekly chart of the S&P500 offers some relevant examples of the Index's potential path. In 2010, the Index fell by more but over a somewhat longer timeframe. It stabilized above 1000 and QE2 was enough to persuade investors back into the market from late August.

By 2007, gradually rising interest rates eventually choked of the credit fuelled binge that had sustained the financial sector for the previous five years. The Index fell below the 200-day MA then rallied back up by mid-2008 only to encounter resistance near the MA and subsequently extend the decline.

Right now, the S&P is becoming increasingly oversold along with just about all other stock markets. In a bear market an index can get oversold and become more oversold as bearish sentiment intensifies. However, as the above examples illustrate, even in a supply dominated environment, brief short covering rallies are possible. Such an eventuality is becoming increasingly likely at this stage.

The current events bring to mind something David has mentioned on a number of previous occasions, most often in the audio. Here is a section from Comment of the Day on October 30th 2007:

"However a crucial point to remember about a crisis - any crisis, is that once known, markets adjust so quickly that the situation has to be seen to be deteriorating for those trends to continue. If the worst case outcome does not look likely, they usually bounce back very quickly."

This one is a made in the Eurozone crisis. Contagion has spread globally but the crux of the problem remains the absence of fiscal cohesion in the Eurozone. The problems with excessive debt and uncompetitive economies on the periphery relative to the core are not going to be resolved overnight.

The most likely solution to this problem will be the issuance of pan European bonds backed by the taxation powers of the entire Eurozone. At present this is not possible because it is not legal. National parliaments will vote on the EFSF deal in September. That is probably a step on the road to pan European bonds. In the meantime, most politicians and senior executives are on holiday and bond yields have surged for peripheral states. Today brought some respite for Spanish and Italian yields but not enough to question the medium-term upward trajectory.