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All Right Now

S&P 500 Index Annotated

I wanted to show you what’s been happening in the market since the last post, and as you can see, the slow grind higher is still in place.

We will have an accomodative Federal Reserve that will keep monetary stimulus flowing, we are approaching earnings season which should again be solid, and consumer spending continues to be strong even in the face of a consumer sentiment report that says they have significant fears of the future. This leads me to believe that the stock market will move higher into year-end.

Looking at the graph above, as we approach the green box which is our target for the market, our plan will be to reduce stock market exposure in client accounts. You can see from the red circle on the left that there is little overhead resistance from potential sellers to a move higher until you get to the green box area. You can also see from the pink line I drew that today’s selloff is being curtailed by the volume at that level which represents previous buyers.

We had several up days that pushed us toward our goal of reaching the green box, but the news out of Europe again has people perplexed. Will a rescue effort for the banks be implemented – will the FLEAS (Finland, Luxemburg, Estonia, and Austria – sorry I can’t take credit for the acronym but also can’t recall who coined it) prevent a bailout of Greece by the European Union – will the banks acquiesce to the IMF and raise capital? No one knows the answer to these questions, but everyone is certain that Europe is in dire straights.

Ted Spread

You can see from the chart of the Ted Spread above that the troubles in Europe are not causing it to forecast a crash in world’s financial systems. However, we continue to monitor it – it is starting to edge up a bit – but nothing like when we experienced the sub-prime crisis and the bankruptcy of Lehman Brothers.

The European news combined with the jobs news today showing that no net new jobs were created last month (public sector layoffs negated private sector hirings) has people perplexed whether a new round of quantitative easing will be instituted by the Federal Reserve when it meets in a couple of weeks. Will that be good or bad for the economy and the markets? Again, everyone is perplexed – QE1 and QE2 were good for the markets (QE1 led to an almost 80% recovery in stock prices and QE2 added somewhere under 20%) but when the programs ended, the markets sold off as we are currently painfully aware of from the chart above. Will QE3 cause a similar rise in the markets? Will it finally stimulate the economy? Will that somehow generate some economic momentum that will lead to increased employment?

You can see that there are more questions than answers. At this time, I am going to stick with my plan for the investment markets..

10-Year Treasury Yields

As for the bond market, you can see from the chart above of the yield on the 10-year treasury note, we are historic lows (this chart is for the past 20 years), so the big risk to bond portfolios is to the upside. Yes, if the Fed employs a strategy of targeting the 10-year note to bring yields down to 1.5% from 2.25%, that will obviously be more profitable for longer duration portfolios than shorter duration portfolios. But, that small upside potential gain is dwarfed by the huge downside risk that the market will go against the Fed and drive bond rates higher as it perceives more risk in treasuries due to our levels of debt.

our plan is to continue to shorten durations in client portfolios that have a fixed income allocation and to add to the variable rate fixed income investments that increase in value as rates move up plus also increase their yields as the general level of bond yields increase.

In summary, today’s selloff does not seem to me to be another leg down in a cascading stock market crash. I think the stock market will be all right and move higher into year-end – but expect some volatility, significant at times. I think the bond market will be flat within a range, but eventually rates will move up and surprise a lot of people that have not prepared for it.

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Enjoy your holiday weekend!