Update 12/10/07

Last week I switched into the S-fund in anticipation that the small/mid caps would see superior gains over the large caps.  This is a trend we have seen over the last few corrections and it appears to be successful.  There is a tendency for the buying to shift from the more stable large caps to the better growth plays in the smaller corporations as the recovery trend becomes more definitive.  I expect the C-fund to top before the S-fund and I want to hang on to this position long enough for the S-fund to play catch up.  If the S&P 500 tops at 1530, which is about 2% above where we are now, the Wilshire 4500 should move to around 700, which is another 4% in the same time period.

In the five year chart below, I’ve drawn the long term channel and included two trend lines that have been critical areas of support turned resistance, vice-versa and been inflection points representing changes in market behavior.  We are at the top of the channel defined by these trend lines, and a move higher from here enters the zone of more speculative behavior.  This speculative behavior can turn sour very quickly, with a little bad news.  The beginning of the last correction was triggered by various write downs.  We may see more of these write downs, more CEO’s fired and more turmoil, but probably not until after the holidays.  

As we move higher from here, we need to be concerned about the market turning on a dime.  For now, I am fairly comfortable with the expectation that we will see 1530 at least, before the next move down.  In the first paragraph, I explained why I want to hold on to the top as long as possible, in second paragraph, I explained why I want to bail at the top as soon as possible.  The reality will be somewhere in between.

The key points for this week are 1) watching for the formation of a top in the S&P 500, 2) keeping an eye on the relative position of the Wilshire 4500 (i.e. catch-up), and 3) keeping an eye on the possibility that the market gains enough confidence that a recession will be avoided, allowing it to push beyond 1530.

The upcoming FOMC meeting will go a long way in effecting the third point.  I don’t think it makes a difference if the fed does a .5% or a .25% cut.  Here’s my logic behind this: The larger cut will have the effect of stimulating the economy, hands down but it will have a secondary minor effect of creating more inflation concerns.  The lesser cut will have a similar primary effect, and a secondary effect of instilling confidence that the fed does not see a recession as inevitable.  Because of this, I see the fed giving a .25% cut but with language that suggests the situation is under control.  The CPI and PPI reports are due this week following the Fed, so inflation will definitely be in the spot light, especially if the fed cuts .50%.  I have no expectations for any specific day this week, but I do expect the week to have an overall positive bias and to potentially present us with a good point to exit the market.
                   


Griffin