Market update – Be the water, not the rock
The market continues to drift higher, climbing that proverbial wall of worry. The old adage of don’t fight the Fed or don’t fight the tape has proven right yet again. (Be the water, not the rock). The markets are rising, leaving many investors on the sidelines scratching their heads. One thing for sure is that what is leading this rally is not the consumer, which has pulled us out of all the downturns over the past 30 years. Unfortunately the demographics of our country simply cannot afford it. Our nation is aging and the baby boom generation which fueled the bull market of the 80’s and 90’s has checked out, quickly becoming a nation of savers from spenders. (See my Economic Tsunami special report) Don’t get me wrong, the current rally is powerful and looks to continue for a short time. It’s just that in order for a sustained bull market, a strong consumer spending cycle is necessary for robust spending. That’s what fuels a strong economy and bull market.

For now, the current rally is being driven by pent up demand from the devastation of last fall, replenishment of inventories and by business spending this time. We are at a major industrial turning point with corporations shedding jobs but modernizing by spending on new technology to replace the workers. Many of the jobs being lost are just not needed in the new economy and they are not coming back.

The government has goosed the economy with stimulus, cash for clunkers and a home buyer credit, all in the hopes of getting the consumer back in the habit of spending. However they’re tapped out, over-leveraged and a beaten pup emotionally after two crashes in one decade. That doesn’t mean stocks can’t keep going up. As to the likely longevity of this sustained market advance—at present there are no overt indications of a major top.

Since the market burst back to life in early July, the rally has shown signs of widespread strength on increasing volume. Buying Power has been in a consistent uptrend and Selling Pressure in a steady downtrend, both signs of a healthy advance. In addition, NYSE New Highs reached a new peak reading this week, as did all our advance-decline lines. Since these indicators typically begin to show signs of deterioration several months in advance of a major market top, things look pretty good for the immediate term.

In fact, the broad based Market Environment Indicator (MEI) has been rising since mid-March, and turned bullish on June 1st, after standing basically bearish since November 5, 2007. On Monday, the MEI broke above a reading of 88 (out of 100). This is a very strong reading and over the past 27 years has only broken above this level 9 times, therefore this is rather significant. Typically when the broad market can make such a statement that both the trend and momentum of the market can reach +88 (MEI reading) it is pretty positive. However this is a topsy-turvy world, and from November 2007 to now, what was black is white, up is down and yes even the Cubs have a chance to win the World Series.

I originally turned positive in early March due to the overwhelming bearishness and pessimism. You may recall my “asteroid hurtling towards earth” commentary. One warning signal I recently got was the investor sentiment numbers which are approaching bearish territory. The way sentiment #’s work is that if there are a lot of people negative and bearish, then it’s a bullish sign and vice versa, as the individual investor is always wrong. They have been decidedly bullish with overwhelming bearishness prevalent since the rally began…until this week that is. Investors are starting to get bullish…and that’s not a good sign. It’s not enough to make me bail out just yet, but it does bear watching. (Like the pun?)

I’ll admit the market looks strong and a recovery underway, at least according to the media. However I remain convinced that we are in a bear market rally, a rally in a larger cyclical bear market. Since the rally began, I have been looking for approximately 10,300 which is a 50% retracement, with an upper channel resistance of 11,700, a 61% retracement. Those are Fibonacci calculations which often hold true in these situations. However it’s not going to hit those levels exactly and bounce off. That would be too easy. It will either get close, trapping those in who are looking at those #’s to get out or it will pierce them, suckering in those who were waiting for a breakout. That’s the most likely scenario, as the market always punishes the majority. No one knows what will be the catalyst, but it will very likely to be something unexpected.

So what is a likely development? Well, the market just had its best performance during the time it usually does its worst, from May to October, thus the old saying, “sell in May and walk away”. The best performing months are usually October to January which has generated 68% of the total return for the S&P 500 generated over the last 20 years (1990-2008) has occurred. Well, as I said it’s a topsy-turvy world, so wouldn’t it be something if the top occurred just as people expected the best period of the year (October to January)…and wouldn’t it be something more if at the same time it hit one of the levels mentioned above…and wouldn’t it also be just amazing if both these occurred as investor sentiment starting getting explicitly positive? It will likely roll over just as people feel that all has been fixed and smooth sailing lies ahead.

Keep in mind that the 1929 crash was followed by a 50% retracement that lasted 6 months, before it turned and plummeted down 89%. It’s important to understand that it didn’t rally back 50% back then because things looked bleak! One thing I will be looking for is a capitulation on the upside, a panic buying on heavy volume. Bouts of buying panic such often presage more substantial market corrections or the outright end of rallies.

Portfolio Strategy – Avoid boats with holes
I will remain cautiously optimistic, “pray for peace but prepare for war” as I like to say. If you are stuck holding the wrong stuff when the market collapses, your leaky boat will sink. I am extremely pleased with our strategy of big dividend stocks and high yielding tax-free and corporate bonds, which has participated nicely without all the risk. Our Top-Down Tactical approach, (TDT™), (over buy and hold/hope) is built for today’s difficult markets.
The key for our clients is typically to get the very best return with the absolute least amount of risk possible. I am a firm believer in getting 60-80% of the upside with only 30-40% (or less) of the down side risk.

The stimulus will continue to have an effect and should move the market higher in the short term and we will be positioned properly, and be able to sleep at night. The most fundamental of decisions we face in building investment portfolios is correctly deciding whether we are faced with inflation, deflation or stagflation in our future. Unfortunately we are likely to face all of these at different times and they all require a different portfolio. Get this answer wrong and your toast. Quite simply, be the expert or hire someone that knows what they’re doing.

*We have a proprietary process for building tax-efficient portfolios for high net worth individuals. Call us today for a complimentary portfolio review or free 2nd opinion on your portfolio.

Economic Update – Prepare for the rapids
Although all seems normal once again, it’s just not possible that entire generation’s excesses have been cured in 7 months. When you come through a 25-year secular credit expansion, it is not going to take months or a quarter. It will take years to bring levels of outstanding credit into realignment with the country's debt-servicing capacity. We are really in this deleveraging process. It is inescapable.

The massive deleveraging is destroying assets faster than the government can inflate. This will make deflation enemy #1. Due to deflation and the widespread excess capacity, both in the labor market and the product market, the only way that corporate profits are rebounding are through aggressive cost-cutting. These measures ultimately come at a cost of lower employment or fewer hours worked, and that feeds right into a listless consumer spending environment that's only really propped up periodically through the generosity of Uncle Sam. It is one thing to have deflation when it comes from an innovation that sparks productivity. However, when you get deflation that is principally driven by deficient demand, that's different altogether.

When you look at the labor market, the 55-and-up age group is the only one that has posted any job growth in the past year. They aren't coming back into the workforce because they want to. They are doing it because they have to. They need the income to make up for the record amount of lost net worth that they endured. From a life-expectancy table, they can see if they made it to 52, they are probably going to make it to 82. They aren't going to make up for all that lost wealth, but there is this growing realization that the boomers are going to have to prepare for retirement the old-fashioned way -- by putting more of their income into the coffee can, as opposed to buying more coffee cans, or shoes, BMW’s and vacation homes.
It's crucial to understand that secular bull and bear markets move in 18-25 year cycles, and to understand that today, we are really only halfway into the secular bear market.

In a secular bull market, corrections are opportunities to build your long-term positions at better prices, as was the case with the crash of October 1987. In a secular bear, market rallies are to be rented, not owned.

Let me know if you have any questions or if I can help with something.

Cheers –Keith
916-925-8900

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Keith Springer is President of Capital Financial Advisory Services, a registered investment advisor, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith at
916-925-8900 or Keith@KeithSpringer.com