Since this is a first run of this brief, I’ll summarize what I have been thinking leading up to the current situation.  For five years we have been operating in a bubble driven, bull market fueled by globalization and rising energy costs, cheap money (carry trade), low fed funds rate and housing market liquidity.  Just a year ago, folks were talking about how the world was “awash in liquidity” and now we find ourselves in a credit/liquidity crunch rivaling the S&L meltdown of the eighties or the energy crisis of the late seventies.   This five year bull run has created a channel that we have operated in which by no small coincidence has yielded about 8.9% a year (or the S&P 500) average.  This channel was created by a significant year long rebound following the lows coming off the post tech bubble burst, followed by three years of more anemic growth characterized by low volatility and 6-7% swings in the S&P 500.  The most recent year has seen a significant rise in volatility due to the bursting of the housing bubble and turmoil in the financial and energy markets, in part fueled by the war in Iraq.   The increased volatility has created much larger and more rapid price changes across the S&P 500, however the 5 year channel remains intact.  In the past couple of weeks, we have slipped from the top of this channel to nearly the bottom for a loss of about 10%.  Now we hear the term stagflation being kicked around and there is significant debate as to an oncoming recession, and plenty of evidence that we are in an economic slowdown.

Despite the economic slowdown (the Stag- in stagflation) we have yet to see the inflation portion rise to a level that would that is significantly outside the Fed’s comfort zone or beyond their control.  Inflation is in check, but the Fed is leery of cutting to stimulate the economy.  In the meantime the dollar has deteriorated to levels that are a concern.

A strict adherence to the five year channel in a linear chart, suggests that 1400 on the S&P is the likely bottom of this chart, if we assume that the five year channel is going to hold – and that is currently an assumption that I am willing to take.  I moved back into the stock market on Wednesday going 100% C-fund.  I did this when we appeared to breaking into the low 1420’s and possibly the 1410’s – my feeling was that is good enough for government work.  While the path down this last sell off has been progressive and steep, it has also been fairly consistent, with a definite trend and fairly tight range. 

This trend is not broken – so we have no confirmation that we have hit the bottom and that the five year channel will hold.  By the time we get that kind of confirmation – we will have given up about 4% worth of gains.  If the five year channel has a breakdown, we can expect to loose about 2% before we can react.  The upside risk is greater then the downside risk.

If I’m tracking the market well, we should see a bottom form.  That could be in the flavor of a tight V bottom, which may produce a playable retest, or in a more whipsaw rounded bottom.  I expect the later due to the emphasis on housing and inflationary reports in this upcoming weeks economic calendar.  If you followed me in on Wednesday, don’t be bummed if you give up all of Friday’s gains over the next couple of days.  In this scenario, we are simply going to hold – unquestionably.

In the earlier scenario – (the V-bottom with a potentially playable retest) we will be looking for a solid rally to 1460 or possibly 1490.  If we see resistance hold after two to three attempts at punch above 1465, I will not attempt to play the retest.  50 points is too fast and furious and if the market follows a pattern similar to August the retest may actually only come down in the mid 1420’s. If we punch above 1465, then we could see 1490 become our play point.   Currently it is my intention to make an IFT at this point – either into the G or F funds as a capital preservation move to play the retest or a move into the S-fund in anticipation of abandoning the typically less volatile C-fund for the higher risk & rewards of the small and mid caps.

Griffin