An Environment of Sector Rotation Than General Trending...

Read a post by Brett Steenbarger and would like to share with friends here. I agree with Brett that the stock market is an environment of sector rotation, rather than a general trending up or down.

"... I follow a basket of 40 stocks, which consists of five highly-weighted issues within each of eight S&P 500 sectors...

Interestingly, after Monday's drop and Tuesday's rise, we have 13 of the stocks in the basket trading in uptrends, 14 neutral, and 13 in downtrends. This suggests an environment of sector rotation, rather than one of general trending...

Weakness in the commodity-related sectors, Materials and Energy, is evident. The two strongest sectors are among the most recession-resistant: Consumer Staples and Health Care... "

Read full post at http://traderfeed.blogspot.com

In View Of Inflation, How Can We Hedge And Protect Assets For The Future?

Just want to share a valid question (below) that we should ask ourselves due to the current economy challenges such as collapse of housing market, subprime mortgage, economy slow down/recession, unemployment rate increase, inflation mainly due to oil price surging, etc, that the American are facing now. If US economy is not able to recover quick enough, the prolong recession in addition to inflation will end up heading to stagflation that need much longer time to recover...

The economy in US might spillover to the rest of the world eventually... Just like the old saying 'if the United States sneezes, the rest of the world catches a cold'.

The sharing below is a blog post by Dr Brett Steenbarger (http://traderfeed.blogspot.com/) answering a question from his reader:

"It's difficult for me to balance what we know about the major theme of government fiscal irresponsibility with short to medium term trends. As you've mentioned, it's one thing to be a successful trader, producing income and another to be financially successful and responsible over the long term. A trader should be able to produce income but what of retirement and all those baby boomers that are going to pull their stock investments at the same time and start looking for income streams? With inflation including public monetization of bad bank loans (private debt) where can you go to get a hedge and protect assets for the future? "

"That's really the challenge of the investor, as opposed to the short-term trader: to, as best as possible, identify scenarios for the future, position oneself to profit from those (or at least to not lose money), and to be sufficiently hedged in the event one is wrong. Many times this will mean acting on scenarios that differ from what you see in the short-to-medium term, which--as Tim notes--can be difficult to balance.

A poor person is one who worries about how to pay the bills. A middle income person is one who worries about funding retirement. A wealthy person is one who worries about leaving enough for the next generation. More assets do not necessarily bring fewer worries, only different ones. When you don't have money, you are worried about making it; when you have excess capital, you're concerned about keeping it.

"Hope for the best, plan for the worst" is advice that has served me well as a short-term trader. By placing your stop-out level, you plan for the worst outcome and ensure you can survive it. Similarly, through diversification and hedges you can plan for the worst as an investor and balance your various risk exposures.

In the last year I've traveled in the U.S. from Miami, FL to Bellevue, WA and quite a few places in between. The common element has been cranes on the skyline. Building continues apace, even amidst indications of a housing oversupply. New luxury developments line the major Naperville street that passes our neighborhood; the houses are not moving, but more are being built.

In one area I visited recently, an entire condominium complex is going under. The developer could not sell enough units and thus could not raise sufficient association fees to properly maintain the development. This led to higher fees for existing tenants and cutbacks in services, including lighting in hallways. Caught in a death spiral, current residents find they cannot sell their properties for even bargain-basement prices: no one wants the liability of paying fees for a deteriorating facility.

Suppose the housing crises winds up much deeper and broader than expected. How would this affect the economy? How would this affect the income of municipalities and their ability to pay off debts? How would this impact banks holding mortgage debt--and how would that affect monetary policy at a Fed fearful of disintermediation?

It's not difficult to imagine a perfect storm for baby boomer retirees, in which interest rates kept low by an accommodative Fed restrain savings income, even as residential and stock market holdings are falling in value and employment opportunities (along with the economy) are contracting.For those concerned about retirement and estate planning, the issue is not so much the specific odds that this scenario will unfold, but rather how one would stay in the game *if* it unfolds.

For those distant from their financial goals, the temptation is to become aggressive and jump in to buy housing bargains, battered financial stocks, and juicy high-yield debt. I remember, too, when plenty of investors jumped in to buy bruised technology shares after their big drop early in 2000. They seemed like bargains when they were 25% off their highs...but wound up more like 75% off their highs over the next two years.

I believe Tim is asking the right question about finding hedges. The tricky part here is identifying whether the ultimate threat is inflation (and soaring interest rates and commodity prices) or deflation (and collapsing rates and financial asset values). For me personally, it's the prospect of a housing collapse, attendant bank crises, and an irresistible push toward quantitative easing at a Fed dominated by appointees from the next administration that leads me to seek protection from a possible perfect storm. As a result, locking in high quality yields and hedging against stock market and dollar weakness has been a dominant part of my increasingly fluid financial planning."

Thanks for your valuable sharing Dr Brett Steenbarger!
Feel free to dropby Brett's blog: http://traderfeed.blogspot.com/

The Gambler

"The Gambler" by Kenny Rogers

He said, son I've made a life out of reading people's faces
And knowing what the cards were, by the way they held their eyes
So if you don't mind my sayin', I can see you're out of aces
For a taste of your whiskey, I'll give you some advice

You got to know when to hold 'em, know when to fold 'em
Know when to walk away and know when to run
You never count your money, when you're sittin' at the table
There'll be time enough for countin', when the dealin's done

Every gambler knows that the secret to survivin'
Is knowing what to throw away, and knowing what to keep
'Cos every hand's a winner and every hand's a loser
And the best that you can hope for is to die in your sleep

And when he finished speakin', he turned back for the window
Crushed out the cigarette, faded off to sleep
And somewhere in the darkness, the gambler he broke even
But in his final words I found an ace that I could keep

The lyrics in this song are applicable to investing in many ways.

Nowhere in the song does "The Gambler" say when to join the game, for entry is by far the simplest part. One only needs the inclination and a stake. It's easy to find a game.

The hand dealt to a poker player is by chance, but the skill is in knowing what to do with it. And so it is with the market, except it's harder in the market because people have to choose their initial hand. Often what instinctively looks and feels good is actually very bad and vice versa.

Once a position has been taken, the investor cannot control the day to day actions of buyers and sellers. We can only apply rules of risk and money management to ensure our "stake" is not wiped out should the market subsequently deal us bad cards later in the game.

Like The Gambler, we can "read people's faces" by studying the interaction of buyers and sellers in any given marketplace. We can directly observe their transactions in terms of price and volume in order to obtain clues as to what may come to gain an edge over other players.

After carefully reading the market, the trader takes a position. The first thing he does is set a stop loss order so that a series of bad trades will not end his time at the table, for once a player has no more money, he must leave the game.
Since no one can predict the market with 100% certainty, every hand is a winner and every hand's a loser if one does not know how to manage a position. In the world of trading, we are interested in tossing out the losers the moment the market lets us know that we are wrong, and giving the winners a little rope, so they may go as far as they can.

The reason most people lose money in the market is because of the fact they have not learned how to trade and/or they have not proved on paper that their ideas are profitable by testing them rigorously. Even if they know how to trade, they will not be around the market for very long unless they know the rules of professional risk and money management and their proper application.

Basically, most traders begin their trading career very undercapitalized and they bet far too large an amount for their account size. The argument from clients was if they already had lots of capital, they wouldn't be "gambling in the market". My reply was that gamblers always lose.

One would not go into business without expertise, a sound business plan and adequate capital, and trading is no different.

A Stunning Collapse, Bear Stearns, One Of The World's Largest Investment Banks

After Bear Stearns Collapse, Who's Next?

Monday March 17, 1:27 pm ET By Joe Bel Bruno and Madlen Read, AP Business Writers

With JPMorgan Deal to Rescue Bear Stearns, Market Wonders Which Investment Bank May Fall Next

NEW YORK (AP) -- With a deal in place to save Bear Stearns from bankruptcy, the company's shares traded above the offer price Monday even as investors began turning a critical eye to other investment banks amid worries about how far the credit contagion could spread.

Despite the weekend agreement for JPMorgan Chase & Co. to buy Bear Stearns for a fraction of its value last week, worries that other banks had sizable exposure to troubled credit markets sent global markets tumbling. The uncertainty was evident on Wall Street, where the Dow Jones industrials sank by more than 100 points.

At Bear Stearns' 47-story headquarters in midtown Manhattan, many employees said they still couldn't believe that the nation's fifth-largest investment bank is -- essentially -- out of business. Employees said there was no meeting to inform employees about what was happening.

"It's my first job out of school. I thought it was a big company -- it would be good experience," said Ki Byung, who works for a division of Bear Stearns. "Now after a couple of months something like this happens."

Instead of making money, Bear Stearns employees trudged boxes of their personal belongings out of the investment bank while JPMorgan managers filed into it for the first time from that bank's headquarters directly across the street. While no layoffs have been announced, analysts expect that they could be significant.

A complete collapse of Bear Stearns might have crushed the already-dwindling confidence in the global financial system, which has frozen up after last year's troubles in the subprime mortgage market.

Bear Stearns was the most exposed to risky bets on the loans; it is now the first major bank to be undone by that market's collapse. But the fact that a major investment bank could reach the verge of buckling -- and be sold at such a discount -- sent dismay through Wall Street and beyond.

"One reaction is shock that a company that reaffirmed its book value at around $84 on Wednesday can be worth $2 per share four days later on Sunday," said Deutsche Bank analyst Mike Mayo.

While employees struggle to find any information they can, the financial industry wants to know exactly how badly Bear Stearns bet on mortgage-backed investments. Unwinding the nation's fifth-biggest investment houses should provide some insight into what other financial institutions might have on their books.

With Bear Stearns seemingly gone, investors pondered who might be next. Lehman Brothers Holding Inc. stock fell more than 34 percent Monday, following a 15 percent drop on Friday amid concerns it might be facing similar liquidity issues. Lehman Chief Executive Richard Fuld denied Monday that the firm was having such problems.

Bear Stearns shares fell $26.32, or 87.7 percent, to $3.68 -- above the shockingly low price of $2 per share that JPMorgan Chase is paying -- while JPMorgan rose $3.03, or 8.3 percent, to $39.57. UBS AG, hit hard by the same type of write-downs for mortgages that felled Bear Stearns, dropped nearly 12 percent in Zurich.

JPMorgan announced Sunday night that it would acquire Bear Stearns for $236.2 million in a deal that was fast-tracked by the federal government to avoid a bankruptcy. The price represents roughly 1 percent of what the investment bank was worth just 16 days ago.

The Federal Reserve and the U.S. government swiftly approved the all-stock buyout to complete the deal before world markets opened. The Fed also essentially made the takeover risk-free by saying it would guarantee up to $30 billion of the troubled mortgage and other assets that got the nation's fifth-largest investment bank into trouble.

"This is going to go down in very historic terms," said Peter Dunay, chief investment strategist for New York-based Meridian Equity Partners. "This is about credit being overextended, and how bad it is for major financial institutions and for individuals. This is why we're probably heading into a recession."

JPMorgan said it will guarantee all business -- such as trading and investment banking -- until Bear Stearns' shareholders approve the deal, expected to be completed during the second quarter. The acquisition includes Bear Stearns' headquarters, which as one of the world's tallest buildings could fetch more than $1 billion in a sale.

JPMorgan Chief Financial Officer Michael Cavanagh did not say what would happen to Bear Stearns' 14,000 employees worldwide, or whether the 85-year-old Bear Stearns name would live on after surviving the Great Depression and a slew of recessions. He told analysts and investors on a conference call that JPMorgan was most interested in buying Bear Stearns' prime brokerage business, which completes trades for big investors such as hedge funds.

At almost the same time as that deal was announced, the Fed said it approved a cut in its lending rate to banks to 3.25 percent from 3.50 percent and created another lending facility for big investment banks. The central bank's official meeting is Tuesday. Before the emergency move to lower the discount rate -- the rate at which banks lend each other money -- the Fed was widely expected to again cut its headline rate by as much as a full point to 2 percent.

Wall Street analysts say the rescue bid was more than just saving one of the world's largest investments banks -- it was a prop for the U.S. economy and the global financial system. An outright failure would cause huge losses for banks, hedge funds and other investors to which Bear Stearns is connected.

After days of denials that it had liquidity problems, Bear was forced into a JPMorgan-led, government-backed bailout on Friday. The arrangement, the first of its kind since the 1930s, resulted in Bear getting a 28-day loan from JPMorgan with the government's guarantee that JPMorgan would not suffer any losses on the deal.

~~~~~

What a shocking news to me when I read the news and saw the stock price of Bear Stearns (BSC) gapped down when market open.

Market React Positively To Fed's Recent Interest Rate Cut...

Last week is a very volatile week for the market averages but posted gains in four out of the five sessions. Small and mid-caps paced the way higher above last week's recovery highs on Friday...

Roughly 20% of the S&P 500 reported their quarterly earnings results in the past week, yet that cascade of results seemed insignificant at times to other developments that included the FOMC meeting, manic reports about bond insurers' credit ratings, January employment data, and a blockbuster announcement from Microsoft that it was offering $31 per share, or nearly $45 billion, to acquire Yahoo!

Looking at the week, the FOMC meeting has to be regarded as the most important happening. The rate-setting committee convened in a two-day affair that culminated in a widely anticipated decision Wednesday afternoon. Specifically, the FOMC elected to cut the fed funds rate another 50 basis points to 3.00%. In a related move, the discount rate was also cut 50 basis points to 3.50%.

The stock market responded favorably to the FOMC decision, sending the major indices sharply higher in its wake. The FOMC-related rally on Wednesday was short-lived, however, as speculation that one of the major bond insurers was on the cusp of being downgraded fueled a sense of angst that led to a broad-based wave of selling pressure.

Still, the indices suffered only modest losses on Wednesday that were quickly recouped on Thursday after MBIA held an assertive four-hour conference call in which it declared that its capital raising plan will exceed triple-A rating requirements and that it was virtually impossible to imagine a situation where it would become insolvent.

On Friday it was also reported that eight banks were in the midst of trying to work out a rescue plan for Ambac Financial.

For the most part, market participants were in rescue mode all week, coming to the aid of battered stock prices, primarily in the financial and retail sectors. The prospect of further rate cuts, and then the rate cut itself, fueled the bullish bias that had been missing for most of January.

The unique element to the past week, though, was the shift in sentiment. Although bad news invited some dips at times in the broader averages, it was the good news that resonated with participants.

To the latter point, if we told you at the beginning of the week that Yahoo!, Google, Boeing, Bristol-Myers and Starbucks would disappoint with their earnings results and/or guidance, that new home sales would fall to a 13-year low, that weekly initial claims would jump to 375K from 306K, that it would be reported Q4 GDP grew just 0.6%, and that January nonfarm payrolls declined by 17K, you would have probably thought we'd be in for more tough sledding.

All of those things happened, yet the market digested them with relative ease, preferring instead to focus on the positives like reassuring earnings news from 3M, Burlington Northern, UPS and Verizon, a report that durable orders rose 5.2%, a jump in the manufacturing sector's ISM Index to 50.7 (a number above 50 reflects growth), and the Microsoft buyout offer for Yahoo!.

The proposed acquisition dominated conversations Friday on account of the 62% premium that the bid represented relative to Yahoo's previous closing price. Additionally, it drew a lot of praise for being a good strategic move on Microsoft's part and raised concerns about a new level of competition for Google, which suffered a 9.0% drop on Friday, bringing its year-to-date decline to 25%.

Underlying all of the positive activity during the week, though, was the Fed and its accommodative policy. The FOMC has now slashed the fed funds rate 225 basis points since Sept. 18 - and that's with initial claims still running below recession levels, the labor market still operating at full employment, and final sales in the fourth quarter, which excludes inventories, increasing 1.9%.

Granted there are clear signs of an economic slowdown, but the Fed is very much acting in a preemptive manner. We think this week's trading action reflected a growing acceptance of that viewpoint. Accordingly, there was broad-based strength behind the move. The financial sector led the way with an impressive 8.5% advance and was followed by telecom services (+6.8%), consumer discretionary (+6.7%), basic materials (+6.2%) and industrials (+5.5%).

The scope of those moves was driven in part by short-covering activity, yet it's not a stretch to think either that in the past week a fear of missing out on future gains following the Fed's rate cuts supplanted the fear of a fallout that has prevailed most of this year.

Enjoy your weekend!

--Patrick J. O'Hare, Briefing.com

Market Rally Towards The Close Of Jan 2008 - Is that the true picture?

The first 5 trading days in this Election Year of 2008 finished down. This has signaled the possibility of a bearish January which in turn a signal of down year for 2008.

True enough, Dow Jones closed at 12,650 on Jan 31, 2008 i.e. DJI is down 611 in Jan 2008. Even the Fed cuts the fed funds rate by 50 basis points to 3.00% and the discount rate by 50 basis points to 3.50% on 30 Jan (Wed) on top of the sudden cut of 75 basis points a week ago, that's not good enough to bring the market up to rally. Do you think the sentiment lifted yesterday due to bond insurer's positive outlook will last? I doubt...

Let's see how will the overall market react today after Google (GOOG), the internet giant, announced disappointing result after market close yesterday. Google tanked $37 to $527.40 after trading hours...

Jan 31, 2008
Dow +207.53 at 12650.36, Nasdaq +40.86 at 2389.86, S&P +22.74 at 12650.36

[BRIEFING.COM] On Thursday, the major indices were able to rally, despite opening sharply lower in the wake of a disappointing unemployment claim report. Sentiment was lifted due to a bond insurer's positive outlook. This is in contrast to Wednesday, when concerns over bond insurers caused the stock market to give up all of its FOMC induced gains.

The major indices finished modestly off their highs on a report released with five minutes left in the session that said Standard & Poor's put MBIA's (MBI 15.50, +1.54) credit rating on negative watch and downgraded FGIC to AA from AAA. Yesteday, Fitch cut FGIC's rating, so its downgrade was not surprising. S&P affirmed Ambac's (ABK 11.64, +0.79) AAA rating.

Despite the S&P report, the major indices still finished sharply higher, led by financials (+2.7%), retailers (+4.4%) and consumer discretionary (+3.4%). These three areas were the main laggards in 2007, and stand to benefit from the recent rate cutting cycle. The Dow, Nasdaq and S&P all closed 3.3% above their session lows.

Bond insurers weighed on sentiment in the early going after MBIA reported a larger than expected loss. MBIA said it had an operating loss of $3.38 per share in the fourth quarter, compared to a profit of $1.16 a year ago.

Sentiment then turned positve, as MBIA led financials and the broader market higher. MBIA's conference call, which lasted four hours, eased traders' uneasiness.

Specifically, the company acknowledged it will have significant losses, but nothing to justify the 80% decline in the share price since last year. The company said its capital plan will exceed all AAA rating requirements. It said a downgrade would impact capital by $100 million to $200 million in a worst case scenario. The company said it will not be forced into bankruptcy and that it is virtually impossible to imagine a situation where MBI would become insolvent.

In economic news, a Dept. of Labor report showed jobless claims for the week ended Jan. 26 jumped to 375,000 from 306,000. Economists expected 320,000 claims. Stocks opened sharply lower on the report. The knee jerk reaction was overdone, as one week does not make a trend, and Briefing.com expected claims to increase due to seasonal factors.

The Dept. of Commerce said December personal income rose 0.5% and spending rose 0.2%, which were mostly in-line with expectations. Separately, fourth quarter employment costs rose 0.8%, in-line with expectations.

All ten sectors closed higher. Energy (+0.3%) underperformed on a relative basis due to a 0.8% slip in crude oil prices.

..Nasdaq 100 +1.8%. ..S&P Midcap 400 +2.2%. ..Russell 2000 +2.6%. ..NYSE Adv/Dec 2384/776. ..NASDAQ Adv/Dec 2039/966.

Feed Shark

Market Forecast of 2008 - What's Your View? (part 3)

Hope you find the previous market forecast 2008 part 1 and part 2 interesting...
Here is the bottom line summaried by Bernie Schaeffer...

The Bottom Line

** I expect that stock-market volatility will begin to recede in 2008 from the elevated levels seen in 2007. As the risk aversion trade begins to unwind, risk appetites will likely return to more normal levels. I also project outflows from domestic equity mutual funds - which approached record levels in 2007 - to moderate substantially and perhaps even revert to inflows as volatility begins to diminish and U.S. stocks begin to rally. Such a reversal would be quite supportive for further gains in the U.S. stock market.

** The fourth year of a Presidential term has historically been bullish for stocks, as has a situation of bipartisan rule (Republicans in the White House; Democrats ruling Congress, or vice versa). Both of these factors are likely to have an impact on stocks in the next 12 months.

** Crude oil may remain near all-time highs, but I would not be surprised if they pulled back to levels that would cause less alarm. The recent surge in prices has been the result of demand, not supply. Consumers have continued to adjust to rising fuel prices, and $3.00 unleaded didn't crimp spending any more than $2.00 gasoline did. In fact, a dramatic plunge in oil prices could potentially signify that something was off with the overall economy or market.

** Earnings across the board will remain challenged as the housing and credit crises proliferate in the coming quarters. But strong growth in sectors such as technology and utilities will help boost the average, potentially well beyond the dour expectations of many analysts. Positive earnings surprises could be a major catalyst for buying power for stocks in the first half of next year.

** Long-term trendlines held up despite dramatic pullbacks this year, confirming that the bull market remains intact. One of the primary moving averages to watch is the 80-week trendline on the S&P 500 Index.

** Concerns that the current market is at risk of a "bubble burst" similar to that endured in 2000 are unfounded. Stocks are priced at more reasonable levels, fear and caution dominates investors' minds as opposed to greed, and there is skepticism (if not downright pessimism) on Wall Street and in the financial press in their outlooks for 2008.

** Look at outperforming, underloved names from the alternative energy and e-commerce sectors for profitable opportunities in 2008 (see below). Metals stocks (particularly from the copper sector) also look promising.

** One sector to avoid in the new year is the large-cap healthcare group. Drug stocks have, as a collective, made virtually no progress this decade after a huge run higher in the 1990s. The combination of the well-known challenges of the industry (generic encroachment, FDA challenges) and continued optimism among analysts should keep capping the appreciation potential of this sector. This is a very broad sector, however, and there could still be some opportunities from the small-cap biotech segment.

** Pay attention to small- and mid-cap growth groups, e-commerce stocks, metals issues, and industrial cyclicals. Also, opportunities in international stocks, which along with multinational companies should continue to benefit from a weak dollar.

** And finally, the real "bottom line to the bottom line" is that while long-term levels of technical support look very reliable, and the backdrop of skepticism is compelling, the wild card is the Fed. All projections come with the very real caveat that an error in monetary policy will almost certainly result in taxing times ahead. The wrong decision could spur a selling campaign that forces long-term moving averages to give way, effectively justifying some of the pessimistic sentiment we've seen. I just hope that Bernanke and his cohorts make the right choice for the economy and the stock market - which is to cut interest rates aggressively without regard to bogus inflation fears.

(Disclaimer: the information provided here is served as reference only and does not constitute financial advice. Pls seek professional consultancy, if needed.)

Feed Shark

Market Forecast of 2008 - What's Your View? (part 2)

Hope you enjoy exploring the earlier market forecast and continue to have fun in part2 of the Market Forecast 2008 by Bernie Schaeffer

Technicals

Key Levels and Trendlines

In the first half of 2007, technical analysts concerned themselves with historical levels. Former all-time highs and significant round-number zones challenged the major market indices, but by the waning weeks of summer, these areas of looming resistance had been overtaken. The Dow toppled 14,000, the S&P 500 Index broke 1,500 and then exceeded its March 2000 closing and intraday highs of 1,527.36 and 1,553.11, respectively. The Russell 2000 Index (RUT) muscled through the 800 mark to hit a new all-time high. And the Nasdaq Composite (COMP) hurdled the 2,500 level to reach its highest point in six years. Additionally, the tech-rich index moved above the 2,566 mark, which represents half of its March 2000 high of 5,132.

The final quarter of the year was defined by a successful test of long-term trendlines of support, which refused to yield even when selling pressure mounted. Most notable is the 80-week moving average on the S&P 500 Index, which contained pullbacks in mid-August and late November. Barring a colossal mistake from the Fed in terms of monetary policy, we have confidence in these levels being supportive heading into 2008.

Where We Could Be Headed

The S&P previously rallied off its 80-week moving average in August 2004, October 2005, and June 2006. The average rally following these pullbacks was 18.6%, and the average duration was eight months.

For the S&P in 2008, I'm looking to a mid-year S&P mark of 1,625, with a move to 1,700 by year-end. So I'm essentially projecting a bigger pop higher sooner rather than later.

For the Dow, I believe we could add about 15% in 2008. By mid-year, I think we could see the average hit 14,600, taking out the 15,000 mark sometime thereafter to close the year around 15,300.

I'd expect the Nasdaq to rise to 2,900 by mid-year and reach 3,100 by the year's close. If the index behaves better than I anticipate, the 3,120 mark could come into focus. This is the 50% retracement point between the index's March 2000 peak and its October 2002 nadir. As for the Russell 2000 Index, I still have faith that some of the best bullish opportunities are in the small- and mid-cap growth area. Retailing growth names, biotechnology issues, and alternative-energy stocks are some particular pockets of strength among the smaller-cap sect. But in recent months, the RUT itself has been weighed down by its components in the beleaguered housing and finance sectors. That said, despite this struggle, I expect to see the RUT retake the 800 level early next year and move to 850 by the middle of the year. By the end of 2008, I'd like to see the RUT hit the 900 mark.

Sentiment

Then and Now

While 2007 faced comparisons to 2000, with the tech bubble of then compared to the housing bubble of now, the reality is that it was a different market environment entirely.

First, stocks are much more fairly priced from a valuation standpoint. As of mid-December, the price-to-earnings ratio on the S&P 500 Index overall stood around 20.50, down from the 37-38 area in late 2000.

Most importantly, the overwhelming sentiment that ruled the market in 2007 was one defined by hesitation and caution. The issues plaguing the 2007 market overshadowed any good news, investors were bailing out of domestic equity funds at record levels in favor of foreign alternatives, and the news stands regularly featured doom-and-gloom predictions.

In 1999 and 2000, greed played a part in every financial decision. The sky was the limit, and losing wasn't on anyone's radar. Euphoria was palpable … and it was dangerous. While I wouldn't say the current market was quite one defined by "despair," it's certainly arguable that we're in the "disbelief" stage.

The Short Story

The short-selling contingent remains a force to be reckoned with as 2007 draws to a close. By the end of November, the total number of Big Board shares sold short rose 3.1% to 12.77 million, up 3% from mid-November, when 12.39 million shares were sold short.

The short-interest ratio reached 8.2 in late November. In other words, total short interest across the New York Stock Exchange (NYSE) is more than eight times greater than the average daily volume on the exchange. This short-interest ratio on the NYSE is on par with the 1997 level, when we were in the middle of a raging bull market.

In addition, put open interest in the options market is at record levels, perhaps a reflection of the huge growth in the dollars managed by hedge funds in recent years. This contingent by definition "has derivatives exposure and knows how to use it".

The bottom line is that the large and ever growing short trade keeps a lid on market rallies (thus reining in any "irrational exuberance") and provides support on market pullbacks (as shorts take profits on declines and as portfolios with put protection in place become exempt from panic liquidation). Market crashes are very unlikely to occur when major money is already positioned for them.

Analysts' Apprehension

The "Big Money Poll," conducted by Barron's every six months, poses a variety of market-related questions to more than 100 investment professionals and money managers.

The latest installment revealed that just 47% of those polled have a "bullish" or "very bullish" outlook for equities through the middle of next year. This is quite a drop from the 64% of managers self-described as "bullish" in late 2005. Profit growth on the S&P 500 Index is expected to be a modest 4.6% for next year.

Meanwhile, 20%, or a fifth of the Big Money Poll respondents, say they are "bearish" or "very bearish" about the market's prospects, up from 17% in the last Poll, conducted in the spring of 2007. Those describing themselves as "neutral" account for 33%, down from 37% seven months ago. This caution among money managers is healthy as markets tend to climb a "wall of worry."

Using Zacks.com data to check in on the overall tone on Wall Street, the percentage of "buy" ratings is underwhelming. Of all analysts' ratings on S&P 500 stocks, just 47.7% are "buys," leaving 46.8% in "hold" territory and 5.5% as "sells."

Meanwhile, in June 2000, when the market's peak had long come and gone, the percentage of "buy" rankings stood at a whopping 72.0%. What's more, 50.3% of analysts' ratings were "buys" even when the market was at its 2002 low!

In other words, the Wall-Street collective is positioned more bearishly right now than they were during the bear market of roughly 5 years ago.

The outlook on mid-cap and small-caps stocks is equally skeptical. Specifically, 42.9% of the ratings on mid-cap stocks are "buys"; 43.89% of small-cap stocks have earned "buy" ratings. This is reflective of a "lowered expectation bar" that is very conducive to analyst upgrades should the 2008 environment prove less gloomy than the consensus believes.

Negativity on the Newsstand

One of my favorite and time-honored measures of anecdotal contrarian analysis has always been the cover story. When a trend in the market (or on an individual stock or sector) has gained such attention that it is appearing on the covers of many widely read publications, it could be about time for that trend to turn. This is based on the theory that once a trend hits the covers it is so widely known and universally accepted that it is set to turn not long after the unsophisticated public jumps aboard based on the "big news" in the cover stories.

A recent commentary from Paul Montgomery, whose work I greatly admire, pointed out the slew of doom-and-gloom headlines we've seen in the financial press related to the housing crisis and the dollar. Granted, as Montgomery also points out, financially-focused magazines don't carry quite the contrarian punch as a more general periodical such as Time, but the contrarian cover-story indicator is still undeniable. Here's a mere sampling of some cover-story headlines we've seen in the past three months:

• BusinessWeek, "The Consumer Crunch," (November 26, 2007)
• The Economist, "America's Vulnerable Economy," (November 15, 2007)
• The Economist, "Lessons from the Credit Crunch," (October 18, 2007)
• BusinessWeek, "That Sinking Feeling," (October 15, 2007)

This is, of course, not to mention the myriad of non-cover articles with bearish themes in the daily, weekly, and monthly press (a recession in 2008 is considered to be a slam dunk). When negativity turns so prevalent that warnings scream to us from the newsstands, pessimism could be nearing a peak. Given the broad market's decent price action amid so many fundamental challenges as highlighted by the headlines we see on a daily basis, this should be good intermediate-term news for the bulls.

Fund Flows

As I alluded to above, one element that makes today's market backdrop dissimilar to the wild ride of 1999-2000 that ended so badly is the fact that investors are bailing out of domestic equity funds. (Around the turn of the millennium, annual fund inflows into domestic funds were setting records in the $200 billion neighborhood).

According to TrimTabs, U.S. equity funds lost roughly $8.3 billion in November alone, marking the seventh consecutive monthly outflow. In May through November, $50.3 billion was pulled out of U.S. funds; this is equal to 56% of the record-setting seven-month outflow of $90 billion seen as the bear-market era was carving out a bottom in June 2002 through December 2002.

But fund players aren't just taking their money to the craps tables or tucking it under their mattresses. Global funds have reaped the benefit of rejected domestic opportunities. In November, $7.9 billion in assets was funneled into global equity funds. What's more, while that $50.3 billion was being erased from locally-based funds, international equity funds have seen $70.9 billion in inflows, huge with respect to the outflows from domestic funds, but small in comparison to the $200 billion in domestic inflows in 2000.

The advent of hedge funds is another major change to the world of investing in the past seven years. And in October, hedge funds posted an inflow of roughly $16 billion (according to TrimTabs data). During the first 10 months of 2007, nearly $280 billion in assets were funneled into hedge funds. In other words, there is a definite preference for funds in which hedging is an instrumental part of the strategy, such as shorting stocks.

So the market in 2007 held together despite headwinds on the economic front and despite headwinds from big money flows into short selling strategies and despite outflows from domestic mutual funds. As fear subsides and the risk/reward profile shifts in 2008, outflows from domestic funds could lessen and possibly even shift back to inflows as pessimism collectively unwinds. A reversal in the fund-flows environment would be very supportive for the U.S. stock market.

Margin Madness

Just a few of weeks ago, I came across the news that the level of margin debt recently exceeded that posted in the 1999-2000 market. This fact seemed diametrically opposed to the sentiment underlying the massive outflows we've seen in the mutual-fund arena, and I hardly believe it's the product of small investors borrowing above their means to buy U.S. stocks (the traditional view when margin debt ramps up).

My sense is that these ramped-up margin-debt figures are tremendously skewed (and rendered practically meaningless) by current present-day factors as hedge-fund activities and exchange-traded funds. (Hedge funds are also largely responsible for the increased demand for short positions referenced above).

Exchange-traded funds (ETF) were practically non-existent during the 1999/2000 bubble, and they are a hugely popular investment vehicle now. There is far less risk in buying an ETF on margin than in buying individual equities.

The risk of buying, say, the Select Sector SPDR Financial Fund (XLF) on margin in no way compares to buying a risky dot-com venture on margin eight years ago. And back to the hedge funds, I'd imagine it would be common practice for them to hedge stocks on margin against short positions in ETFs on margin for a net trade that is actually lower risk than buying stocks with cash.

Stay tune for the summary and net-net bottom line that is going to be revealed in part 3...

Market Forecast of 2008 - What's your view? (part 1)

I read this interesting Market Forecast of 2008 by Bernie Schaeffer.

Just want to share with friends here too...

Year In Review

Imagine the impossible happened around this time last year. You're minding your own business with a nice cup of green tea and you're presented with a truly functional crystal ball (or the souped-up time-traveling De Lorean from Back to the Future). You suddenly have the ability to look one year into the future - a dream come true for an investor (or gambler). With your newfound clairvoyance, perhaps you'd decide to keep those Apple shares in your portfolio or invest in a little thing called Baidu.com. Maybe you'd laugh at the notion of the Boston Red Sox capturing a second World-Series crown in four years. You'd be incredulous at the notion that Kevin Federline would be ruled a better parent than his estranged wife Britney Spears. And then one little prophecy would be absolutely flabbergasting.

The crystal ball (or your "future self") would warn of a hiccup called "subprime," a problem that grew out of short-sightedness and flourished in an environment riddled with rising interest rates and falling home prices. Foreclosures hit record numbers, major mortgage lenders crumbled, and homebuilders hit the skids. The crisis had a self-perpetuating effect - gun-shy banks and lending institutions were hesitant to offer credit, making the landscape that much more challenging for home sellers and builders.

This meltdown in the mortgage market trickled down into global credit markets, as liquidity evaporated. Hedge funds that were largely invested in subprime equities collapsed, banks and brokerage firms wrote off billions of dollars in bad debt, and the merger-and-acquisition deals that dominated headlines in the early part of 2007 became few and far between. Earnings were stunted for financial and homebuilding names, leading to aggregate results that fell short of already-lowered expectations late in the year. And on top of that, crude oil made a charge at the $100 a barrel.

So a clairvoyant investor at the end of 2006 would foresee a shrinking credit market and sparse relief from the housing market's infirmity or crude oil's climb. But if the crystal ball broke before he went back to the future to check out the stock market in 2007, hopefully he didn't spill his tea and rush to protect his portfolio against the worst bear market of the past 15 years. Because - and this is where the other shoe drops - despite all of this madness that transpired but 11-plus months in, the major market averages are sitting near breakeven or even slightly higher for the year. In fact, the Dow (DJIA) overtook two millennium marks (13,000 and 14,000) for the first time, the S&P 500 (SPX) hit a new all-time high, and the Nasdaq Composite (COMP) surged to a new six-year peak. And these gains occurred after the subprime crisis began to reveal itself. Someone looking a year into the future would never believe it. But then, going back to the Red Sox and Kevin Federline, 2007 has been a year of outrageous events.

When you look at all we've stomached, it's frankly quite impressive that stocks have weathered the storm. In light of the fundamental struggles that have plagued the market environment of late, long-term technical support and a sentiment backdrop of caution and skepticism have kept cataclysmic selling at bay. The three separate rate cuts from the Federal Reserve (amounting to a combined drop of one percentage point) have also certainly helped, but they arrived a little late (more on this later).

Currently, we're facing the monetary equivalent of a double-edged sword. Bad news on the economic front is clearly undesirable, in that we never want to see symptoms of an economic slowdown. But if the news is bad enough, the collective conclusion is that the Fed's hand will be forced, spurring another rate cut, and a return to a low-rate environment can signal good news for the market's recovery and the eventual upturn in the housing and credit markets.

As we shift gears into 2008 - a Presidential election year - we look to the Fed for answers. They are the one major wild card here, and a policy misstep from the central bank could cause an unraveling of the technical support that has been so pivotal for keeping the market on an even keel.

Fundamentals

Ben There, Done What?

In the past few months, there has been plenty of hemming and hawing among the most powerful men and women in finance, as Fed officials worry that continued rate cuts could steer the market into an inflationary spiral. I simply cannot emphasize enough how imperative I think it is to this market that an aggressive rate-cutting campaign continue into 2008. I remain floored by the articles I read listing every indication why the bottom will fall out amid the subprime-crises mess, and how many of these pieces fail to even hint that a rate-cutting campaign from the Fed could help ameliorate this problem.

Of course, the hawkish advocate will argue inflationary pressures and the weak dollar. First of all, the greenback stands to benefit from a more prosperous environment - currency traders are as worried as anyone about an implosion in the U.S. economy. And as I've noted before - in The Option Advisor and on SchaeffersResearch.com - lower rates are already built into the dollar - it is the Fed that is lagging behind market rates. With regard to inflation, it is mind-boggling to me that this is a serious concern in the wake of a deflationary banking crisis, a scenario that has never been followed by accelerated inflation.

The yield on the two-year note is below the 3% mark. Libor rates are reflecting a level of tightness in the market not seen since the early 1990s, when we were plagued with the savings-and-loans crisis. The yield curve for the Fed funds and 10-year note has been inverted for nearly 560 days and counting - but we've yet to see recessionary indications. The point is - we're looking at the risk of deflation here, not inflation. This market and this economy need more rate cuts, and if we don't get them, all bets are off.

Recession Ruminations

The idea that the economy is poised to tap the brakes may appear at odds with the notion that stocks will continue to trend higher. In fact, these seemingly diametrically opposed concepts have a historical precedent of going hand in hand. Data reported in a December 10 Bloomberg article reveals that in the past 60 years, the S&P has moved higher in eight of the 10 years that the economy has grown by 1% or less.

But here's the rub … six of those eight increases coincided with periods during which the Federal Reserve was dedicated to a rate-cutting campaign. Since the 1950s, the Fed has cut rates at least three times consecutively on 12 different occasions. In 11 of these instances, higher stock prices followed; the S&P posted an average annual gain of 19.2%. What's more, in the six years when these rate cuts coincided with economic growth of 1% or less, the average gain in the S&P was 23%. Are you listening, Ben?

Earnings Expectations Expose Ennui

When it came to earnings, the trend toward the end of 2007 was increased caution, which came in the form of reduced estimates. By December, the average estimate for fourth-quarter earnings (the lion's share of which will be reported in January) was less than 1.7%. For 2007 as a whole, total earnings are on pace to grow 3.2%, the worst collective earnings growth rate since 2002. This is down from the 9.3% earnings growth projected at the beginning of the year.

This backdrop shows me two things.

First, it's another testament to the underlying strength of the market, which was able to hold steady despite such a disappointing turn in the earnings department. Additionally, from a sentiment standpoint, these low expectations, which are likely to trickle into early 2008 outlooks, sets up the potential for upside surprises to blaze a trail through the market early next year. When analysts and investors are expecting the worst, the slightest bit of good news can spark buying interest. Also remember that the overall earnings picture has been clouded by weakness in finance and housing. Take these problematical pockets out of the equation, and earnings remain on solid ground - perhaps on shockingly solid ground as evidenced by recent very strong earnings reports from major technology stocks.

For the S&P 500 Index overall, I expect earnings growth of around 7% in 2007. My assumption is that consumer spending will not suffer a major hit next year, as Fed rate cuts (again, the wild card here) and other steps to ameliorate the housing slump will shore things up. I'm also expecting to see oil prices moderate and income growth remain strong.

While the financial sector will face continued earnings challenges as the impact of the credit-market woes trickle down, this weakness will be offset by strong earnings growth in such sectors as utilities and technology. I'd expect the weak dollar to act as an overall economic stimulant in addition to boosting the overseas earnings of multinational companies and encouraging foreign buying of U.S. assets. If the Fed cooperates, fourth-quarter 2008 earnings growth could rebound strongly across all sectors, causing a real surge in buying demand.

Lame Duck = Good Luck?

For the first time since 2000, one thing is certain in the upcoming year's political landscape … by the end of the year, a new person will have been elected Commander in Chief (I'd say by the end of Election Day, but we've seen how that can go). No matter the turnout - Democrat, Republican, man, woman, Hollywood actor, or dark horse - the White House will have a new resident come January 2009. What does the changing tide mean for the stock market? Potentially a lot.

But before we get to our 44th President, let's see what we can expect from the final months of George W. Bush, from a market perspective. Historically speaking (back to 1952), the fourth year of the Presidential cycle has been the second best for the market (the best being the third year, although this cyclical pattern didn't live up to expectations in 2007). On average, the fourth year in the Presidential cycle has seen an average annual return of 7.35% in the broad market. The best year by far was 1996. As Bill Clinton easily nabbed a second term against Bob Dole, the market charged 26.01% higher. The worst two years were 1960, when the market fell 9.35% and a controversial election resulted in John F. Kennedy defeating then-Vice President Richard Nixon, and 2000, when the market gave back 6.18% amid the technology bubble-bust.

It's also interesting to note the potentially bullish impact of bipartisan rule. In the past, a discord between Congress and the President has been good for the stock market (possibly because warring factions lead to inaction by government). Noted economist Ed Yardini once observed: "I wholeheartedly encourage people to vote for gridlock; it's good for Wall Street and for Main Street too."

Currently, there's a stalemate, with the White House controlled by Republicans while Democrats hold Congress. Next November, with 35 Senate seats and the Presidential slot up for grabs, we could wind up with a change in both branches. This will be something to keep in mind as we make our financial decisions for 2009.

Crude Awakening

In the fourth quarter of last year, the price of crude per barrel was lower relative the first quarter of 2006. This was certainly not the case this year, as black gold muscled continuously higher for most of the year and briefly threatened to overtake the psychologically significant $100 level.

At press time, long-term crude futures were nearly 43% higher for the year and the average price at the pumps (for regular-grade unleaded) was still hovering around $3.00. The simple fact of the matter is, since crude toppled the $30-per-barrel level in May 2003, black gold has been on an indefatigable run higher. People lamented $50-a-barrel oil and $80-a-barrel oil. And though the rising price of fuel has ultimately impacted everyone, from the commuter fueling up every week to the airline traveler feeling the brunt of higher ticket prices (to the consumer, who has seen the cost of many products increase to compensate for rising fuel), the overall jump in crude futures has been somewhat of a non-issue for the stock market.

Though oil has tripled in value in the past four-plus years, economic growth has remained healthy. The annual gross domestic product (GDP) rose an average of 5.95% from 2003 through 2006 and is currently expected to rise approximately 4.8% in 2007. Unlike the oil crisis in the mid-1970s, when supply was crimped, prices spiked, and filling stations were forced to deal with lines of frustrated customers, today's gains in oil are the product of increased demand. If we were to see oil suddenly fall back even as low as the $50-per-barrel mark, it would probably be the result of some deeper-seeded economic issues. Consumers and the economy have put up with rising oil this long; fuel costs should continue to be digested rather effortlessly in 2008 as well. However, forecasts for GDP growth in 2008 are just above 1.5%. Thus, a slowdown is factored into the market.

Finally, from a contrarian perspective I note that those forecasting crude oil prices for 2008 have adopted a "fool me 10 times, shame on me" attitude, vowing that they will not again be fooled into predicting (as they have, year after year) that the price of oil will revert to the mean and retreat. One of Mr. Market's favorite tricks is to blow away those who modify a long-held stance because they feel they've finally "learned their lesson".

Stay tune for more from part 2 that will further analyze the technical trend and market sentiment...