Not a clear environment yet

A rally has developed off of historically low sentiment and weekly trend channel support in the S&P. August is the second worst month historically, and September the worst, for the market, so seasonally we are not approaching the best period ahead. Volume and breadth trends have not been as strong as would be preferable for a sustained resumption of the bull move as of yet.

Fed action or non next week may dictate a few days of high volume activity and bears watching not just in terms of market reaction but in terms of what the Fed is saying and paying attention to. Futures markets are discounting a less than 40% chance of a rate hike in August. We suspect the odds are tilted a bit more in favor of a hike than even, though not substantially -- and what the Fed does and says this next week may become quite important in setting a new environment. There IS evidence of a slowdown materializing in the US growth rate. Housing in particular is weak, as are auto sales. Consumption is showing BEGINNING signs of weakening. Yet the ISM manufacturing index is still above levels normally associated with a pause in Fed tightening. And most significantly, inflation gauges are still pointing to higher inflation, even while growth slows. The past quarter was actually minor stagflation. We suspect that lower growth while lagging inflation gauges (and lagging rent measures) continue to rise may obtain for another month to quarter.

Bernanke is considered an expert in the so-called “sacrifice ratio,” which roughly measures the amount of employment growth you give up at a given time by tightening more in order to prevent an inflation problem from getting out of control in the future. The sacrifice ratio is currently quite high, meaning it would be judicious to err on the side of being too tight. Bernanke cannot afford to let the inflation genie out of the bottle, and as inflation gauges climb, we suspect he will be pressured to either raise rates or consider doing so heavily enough that a “tightening is over” full-scale rally will not be at hand yet. The key will be in his comments this coming week. If the Fed pauses but still notes that higher inflation gauges could lead to further tightening, or if the Fed tightens but does not make it absolutely clear that this is the last hike, market reaction could be muted on the upside. On the other hand a pause with comments of confidence that hikes are behind us, could lead to a non-explosive further leg up to at least test the highs of earlier this year. A STRONG close by (TLT | Quote | Chart | News | PowerRating) over its double bottom resistance will be an important clue that the markets are starting to look beyond current inflation numbers.



Regardless of the Fed’s move and comments, we should let market action be the guide. Strong rallies in the major averages accompanied by high volume to create a follow-through day would be the first sign of more upside ahead. The real excitement may not come until the breadth of Top RS new highs starts to expand broadly and stocks meeting our runaway up fuel criteria begin to break out with some plurality. Until then, we still suggest keeping your powder mostly dry.

We still like Large-Cap-Value over small caps and (PPH | Quote | Chart | News | PowerRating) over the market as some of our favorite plays. Yet we still regard this as a TREACHEROUS ENVIRONMENT where CAPITAL PRESERVATION SHOULD BE PARAMOUNT. Don’t allocate heavily to anything that doesn’t scream at you.



The Israeli-Hezbollah War has FINALLY evolved into a ground war as we anticipated in our prior comments. Now it’s a race. The Israeli’s must try to do as much damage as possible to Hezbollah before they are forced into some sort of peace initiative that compromises their goal of doing lasting and material damage to this terrorist organization that is armed with more weapons than Lebanon itself and continues to be able to send Iranian missiles into Israel at will. For Hezbollah they will try to hideout in their prepared bunkers and necessitate as many casualties as possible on Israel while hiding their missiles and trying to maintain their ability to fire them at any time. Some global leaders have expressed a deep concern that world opinion does not understand the potential of what is at stake in this war. If Israel cannot do lasting and material damage to Hezbollah, who innovated suicide bombing, it will teach Iran and the radical Islamic world that terrorism is THE way to achieve its objectives, and global terrorism will soar. Iran may even suspect that the west is so spineless that they will not stop it from acquiring nuclear weapons -- and the potential is for the Islamic terrorist war to become MUCH more widespread down the road than if a lesson is taught now. Appeasement to terrorists may simply create a much more widespread conflict down the road. This fight MAY be much more important than most realize in shaping the environment of the next decade. Whether this opinion is true or not, it is at least probable that the War has and will continue to effect markets and add uncertainty and risk to any potentially bullish outlook.



Sometimes the sidelines are the best place to be. We suspect we’re still in one of those times. Conflicting forces continue to grow, and high odds sustainable moves don’t appear likely to materialize just yet. Until they do, we suggest mostly keeping your powder dry and watching events transpire closely.

Our US selection methods, our Top RS/EPS New Highs list published on TradingMarkets.com, had readings of 26, 26, 31, 18 and 34 with 18 breakouts of 4+ week ranges; no valid trades meeting criteria, and no close calls. This week, our bottom RS/EPS New Lows recorded readings of 34, 23, 13, 32 and 21 with 10 breakdowns of 4+ week ranges, no valid trades and no close calls. The “model” portfolio of trades meeting criteria has some time back exited all positions and is 100% in cash.



Mark Boucher has been ranked #1 by Nelson's World's Best Money Managers for his 5-year compounded annual rate of return of 26.6%.

For those not familiar with our long/short strategies, we suggest you review my book "The Hedge Fund Edge", my course "The Science of Trading", my video seminar, where I discuss many new techniques, and my latest educational product, the interactive training module. Basically, we have rigorous criteria for potential long stocks that we call "up-fuel", as well as rigorous criteria for potential short stocks that we call "down-fuel".

The “2006 Investment Roadmap” is also my best effort at explaining the top secular themes that every trader should be focused on in their portfolios. A special offer of this exclusive report is available to TradingMarkets.com clients at www.midasresourcegroup.com. So far the groups highlighted in the 2006 Investment Roadmap are exploding in value and appear set to continue to do so.