After a couple of good months Greek jitters returned and rattled markets.  International stocks experienced some of the biggest declines.  Developed market international (EFA) stocks fell -3.19% and emerging market (EEM) stocks declined -3.34%.  A majority of the developed country international stocks are located in Europe which helps explain why that asset class is currently underperforming.  Some emerging market countries, while more geographically dispersed, rely on exports to the European region for economic growth.  With many countries in the European region on the brink or in recession, Europeans may be spending less on foreign goods.

U.S. markets held up much better for the day and continue to lead global equities. 

• S&P 500 stocks (SPY) fell -1.45%
• NASDAQ 100 (QQQ) was down -.98%
• Dow Jones Industrials (DIA) declined -1.52%
• Small cap stocks (IWM) took the biggest hit of the group, down -1.99%

Stock market action again confirms the benefit of owning U.S. stocks over international stocks in the current environment.

Most of Tuesdays selling came from renewed trouble with Greek debt. 

A "Trillion Dollars", that is the rough estimate of the damage the Institute of International Finance suggested would be caused if private bond holders, some of whom are Greek pension funds, do not agree to take a nearly three-quarter loss on the value of their Greek debt.  A critical March 20th payment by Greece, if missed without an agreement in place, would constitute a hard default and trigger a series of consequences.  The manner in which the losses are being forced is a very interesting story and another example of how government can pick winners and losers.

A looming deadline this Thursday needs at least 75% of the bond holders to agree to take the nearly 75% loss which would allow collective action clauses (CACs) to be triggered forcing those bondholders who own bonds governed under Greek law to participate.  Some of the bonds in question are governed under Swiss and English law, further complicating the matter.  The legal action surrounding the Greek debt situation is a good reminder of the challenges that can face bond investors.

The market deserves a rest and additional selling may materialize.  Ideally the S&P 500 index won't fall below 1,290. A move down to that level would generate a 6% decline from the March 1st high, a reasonable pullback given the markets nearly 22% rise since October.  A better case scenario would be for the index to find support at its 50 day moving average above 1,300 but pullbacks in this market have not been as cooperative.

The current rally in gold may have stalled with the price for GLD falling below recent lows in huge volume yesterday.  This is not the type of trading action you would expect from an asset that is under accumulation.  It is beginning to look like an asset under distribution.  GLD was able to recover some of yesterday's decline in trading today which helps establish a short-term support level around $166.

Gold has been experiencing a lot of volatility over the last 6 months.  On the weekly chart below we see the 50-week moving average around the $160 price level.  The last time GLD traded down to its 50-week moving average was back in December when it bounce off the line and advanced higher.  The 50-week moving average will be another important support level to watch in the coming weeks if GLD continues to decline.

It is difficult to know what is driving the selling.  Some commentators believe gold will double from the current price level.  One reason money may be leaving gold is due to the rally in stocks.  Stocks are currently outperforming and investors may be leaving GLD to put money into stocks.  As for my model, metals remain at the bottom of my list.  Currently I am finding better investment opportunities in U.S. stocks but I expect my clients will own gold again in the future.

Gold continues to recover from its recent selloff.  The yellow metal started the year strong with a big rally in January.  It took a breather to start February but has continued its move higher.

In the chart below we can see GLD has moved past is last stopping point in early February, around $171.  Other than the spike in volume mid-January, trading remains somewhat muted.  The blue 50-day moving average remains above the red 200-day moving average.  This is an important characteristic.  The last time the 50-day fell below the 200-day was back in 2008, when gold took a huge nosedive.

The next big test comes at $175 and then the all-time high of $185.  On the weekly chart we see how GLD bounced off the 50-day moving average, just how you want a price consolidation to resolve to the upside.

As you would expect, the chart below looks similar to the GLD chart.  But there are some important differences.  Gold miners suffered a more severe price pullback.  The blue 50-day moving average line is still below the red 200-day moving average line.  Current price action is stuck at the 50-day moving average, a point of retreat earlier this month.  An inability to move above the 50-day would be bearish development for gold miners and gold.  Interestingly, volume looks healthier in the miners with several gray bars piecing above the 50-day volume average at the bottom of the chart.  This tells us there has been some more buying as the gold miners work out of their current doldrums.

Gold miners are notoriously volatile.  In addition to the spot price for gold, gold miners are operating company with businesses influenced by a number of different factors.  For this reason I prefer GLD for exposure to the yellow metal but will consider GDX if precious metals become one of the few asset classes attracting money.  The theory behind the Chinese accumulating massive gold reserves may have merit and is worthy of continued observation.  Much of their activity is cloaked in secrecy but the scale of that type of operation would leave a signature for those paying attention.  Keep an eye on the yellow metal.  Prior to this new theory, the fundamental arguments supporting a continued move higher for gold were less sound, in my opinion.

Right now the metal investments we track are at the bottom of the list for investment consideration.  A wide variety of stocks and even bonds are ranked higher based on the criteria we use to make investment decisions.  If gold continues to perform, it should move up our list.

I know a lot of investors are still leery of owning stock based investments.  The last 10 years have been brutal for stock investors.  If you have spent any time reading investment commentary by leading managers over the last few years you know how challenging the current environment has been.  For example, if we compare the 2003-2007 rally with the 2009-2012 rally we see more volatile environment in the latter.  Small price corrections in stock markets should be expected, but when you start to see double digit declines within a questionable economic environment, investors should be concerned and prepared to take action.

So far the current market is acting like it wants to continue to rally.  We can see in the chart below that stocks have been able to move through two resistance levels since October.

For those investors that are trying to figure out how to enter this rally, I would remind them our model triggered our first stocks-based exchange traded fund (ETF) investment back in November.  Since then we have added two additional stock-based ETF positions.  If the market holds it looks like we will add more in the near future.

At present one of the stock-based ETF positions we hold has a defensive nature.  This was the first stock-based ETF our model triggered and is represented by the Dow Jones Select Dividend Fund (DVY).  Utilities and Consumer Staples are the largest sectors represented presently and the fund tends to hold larger companies, with an average market cap of $26.7B and a median market cap of $7.7B.  Collectively these traits may help reduce volatility.  However, if the market rally is sustained it looks like this investment will be sold and replaced with a more growth oriented stock-based ETF investment.

We also hold the Dow Jones U.S. Real Estate Trust (IYR).  This investment has performed very well but is also on the verge of being sold.  The Nasdaq 100, Small U.S. Companies and Financials have move into higher rankings.  We already own the Nasdaq 100 (QQQ) and it is currently ranked #1 in our model.  It is import for new investors to understand part of this rally is behind us.

One way to approach the current environment is to start with more defensive investments.  At present only 60% of our model is in stock based investment.  We still hold an investment in Corporate Bonds, for example.  The other option is to take partial positions in the more aggressive investments.  If the investment continues to perform you can purchase the full allocation, ideally on a pullback.

You want to be careful at this point in the rally.  From the December low the S&P 500 (SPY) has rallied 13.4% and 24% since the October low.  Year-to-date the S&P 500 is up 8.7% - a remarkable run in a month and a half.

A quick update on international investments, one emerging market position has moved up and is close to being consider for investment.  As I have mentioned several times in the last couple of months, international investments have been absent from our investment mix because of their low ranking in our model.  It would be rare if our model triggered a full allocation exclusively to U.S. based stock investments because it has a low long-term correlation with the S&P 500.  There are shorter term periods where the correlation moves higher and this may be one of them.

Stocks may have more energy for a move higher from these levels but with each passing week the likelihood of a pullback increases, so have an investment plan and a system for implementing it.

Since the October bottom U.S stocks have led the charge higher.  Not only when compared to International stocks, but other asset classes as well.

In the chart below we see U.S. stocks are back to their August highs.  International stocks, however, remain well below those levels.

The performance difference is even more dramatic between U.S. stocks and commodities.  Commodities have not been able to sustain a move higher.

There has been a big shift in leading investments since the end of November.  So far U.S. stocks remain firmly in the lead and are poised to keep their leadership position.  Recently the financial sector has even started to show some strength.  Despite our debt and unemployment problems, the U.S. is the most resilient economy on the planet. 

Europe, on the other hand, is a mess and may remain volatile for years as they work through debt challenges.  As for emerging market countries, many remain sensitive to the slowdown in trade the debt crisis in Europe has caused.  So far in this rally, U.S. stocks have led the way.

Poor performance by commodities would explain part of the reason the Canadian stock market is doing so poorly.  The rally in the dollar since last fall has pushed prices down.  Notice how closely Canadian stocks have tracked commodity prices.  That is understandable given their economy's dependence on natural resources.

We have seen an interesting development recently between stock prices and bond yields (current return).  They usually move in the same general direction which has been the case for most of the last few years.  When stocks rally bond prices often fall, which sends yields higher.  But this trend has been broken recently.  As the chart below illustrates, bond prices are holding firm which is keeping yields at low levels.

Normally we would expect bond yields to rise along with stock prices.  With the Fed busy in the market buying bonds as a result of Operation Twist, prices may be elevated which would hold yields down.

The chart below illustrates the inverse relationship between bond prices and their yield.  It is very clear from the chart that prices and yields are at extreme levels going back to 2000.  Since Operation Twist is expected to end in June, if the economy has strengthened further between now and then we can expect a move down in 10 year bond prices.

There are some commentators who suggest gold will see $2,000+ an ounce in the next several years as the U.S. dollar depreciates and inflation takes hold.  As we get closer to the lower end of that target it would be wise for gold investors to start formulating an exit plan if they intend to lock-in profits.  Gold is currently selling for around $1,730 an ounce.

Gold has been a top performing investment for over 10 years and periodic price declines should be expected after an investment delivers strong growth.  At some point the long-term trend in gold will reverse and those investors who want to capitalize on the meteoric rise need to be on guard for a change in the upward trend.  In the meantime, investors in gold need to balance the possibility of more upside, potentially much more.

One of the way investors can get exposure to gold is through the exchange traded fund, SPDR Gold Trust (GLD).  Let's take a look at the most recent correction in the price of GLD to see what it can tell us.

The chart above shows a near vertical upward move in July and August that has some of the characteristics of a blow-off top (a near vertical price rise).    In this case there was good volume supporting the move.  In a classic blow-off top volume fades as the price rises.  This is not the first time GLD has experienced accelerated moves to the upside but it is this type of price action an investor should watch closely.

After declining just over 15% from highs back in August the precious metal staged a couple of rally attempts.   The first line (1) above marks the top of the rally attempts GLD has staged since the selloff began.  The second selloff in December, after a reasonably good rally in October and November, raises an eyebrow.  It looks like investors lost confidence in the ability for GLD to move higher and instead of buying, sold another large quantity of shares.   This is a mark of distribution, where a lot of selling takes place on declining prices.   The circles at the bottom of the chart bring attention to the spikes in selling that took place throughout the last five months.  More recent price action has broken through the earlier downward trend line, the first sign of hope for a return to the uptrend.  The move higher was also accomplished with good volume, another positive development.

Line number (2) represents the first area of support. This level was maintained for much of the selling but was broken twice in late December.  Not exactly the type of action you want to see in an asset attempting to recover an upward trend.  Ideally GLD will stay above the $155 price.  A move below it would serve as the first warning that more selling may be on the way.

Line 3 represents the top of the rally attempt from October and early November.  Line 4 represents the top of the rally attempt at the end of November.  GLD is bumping up against line 4 now and needs to break and hold above $170, then $175 to move back into an upward trend.  Bottom line, until a sustained move above $175 materializes, GLD could be subject to more selling or sideways action.

It may be GLD needs more time to consolidate recent gains and additional selling could take it below the $155 support mentioned above.  If we look at a monthly chart we see the next level of support is around the mid-$140s.  As long as GLD holds above that level the trading action could still be considered a price consolidation within a long-term upward trend.  Like anything running up a hill, it needs to rest periodically; if we see GLD move below the mid-$140's over the coming months, however, that could mark the beginning of the end of the run.

It is really difficult to make sense of price movements in today's markets.  There are so many variable at play it is difficult to ascertain what is driving the price movement at any given time.  One week it is liquidity, the next week it is bond yields in Europe and then monetary action.  That is why monitoring price movements for clues about the future direction of the investment can be helpful.  It doesn't matter what fundamental reason you have for an investment, if the price action is acting contrary to your thesis, you may have it wrong.

At different times during gold's rise clients at Dightman Capital have held an investment in the asset class.  At present, however, GLD holds the second to last spot in our investment rankings, just above Silver (SLV).  GLD will someday make its way toward the top again and if it gets high enough, we will invest.  Until then, we are finding better opportunities in other investments.

For those holding investments in gold it looks like a period of price consolidation is underway.  The $155 and $145 price levels for GLD hold important support levels that if broken in the near term, may mark an end to the current bull market in gold.

DISCLOSURE:  Our strategies do not hold any positions in precious metals at the time of this writing.

Stocks continue to power higher as we start the month of February.  A continued improvement in economic data has helped the advance along with reasonably good Q4 earnings.

Even with all the good news the U.S. economy has a lot to prove before we can feel like the engine of growth is running smoothly.  We saw 200k+ gains in payrolls in the spring of 2010 and 2011 that ultimately were not sustained.  With housing still depressed and a euro-zone crisis flare up possible at any moment, this rally could be short lived.

Right now growth assets are clearly leading the market.  We saw defensive industries start to underperform at the end of 2011.  As investors moved out of Consumer Staples and Utilities they have moved into Materials, Finance & Technology.  If Finance can continue to lead that would further bolster the prospects for an expanding economy.

Click To Enlarge

International stocks are also starting to participate in the rally.  After significant declines in 2011 international stocks are starting to perform on par with U.S. stocks.

SPY - S&P 500 Fund, VEU - Vanguard All-World Ex US

Not only have prices been on the rise for risky assets but they have cleared technical hurdles along the way, adding another positive development.  The NASDAQ 100 offers an excellent example.

After trading in a range for much of 2011 the NASDAQ 100 was able to move past highs set back in August; it would be nice to see more volume return to the market.

At the end of December only three growth investments from my current investment universe outperformed cash.  At the end of January the number had grown to five but did not include any international stocks.  However, throughout both time period's two bond investments were still ranked in the top five so stocks still have some work to earn more representation in our strategies.  At the rate the market is progressing it may not take long.  At present we hold three growth investments, two bond investments and two hedged investments.

Overall the market character has clearly turned more bullish.  Let's hope it continues but given the secular economic challenges still faced, investors would be wise to stay nimble.

On Friday the 13^th global investors received two pieces of disturbing news.  S&P downgraded nine of the 17 countries in the euro zone, including AAA rated France, and Greece was unable to get private bond holders to renegotiate terms. 

The posturing and motivations between the parties in the Greece situation are many, but without a restructuring of debt (orderly default), the country could face a disruptive bankruptcy in coming months.  Unfortunately, as we know Greece is only one of the problem debtors in the region.

U.S. stocks have been surprisingly resilient during the latest chapter for the Eurozone crisis.  Normally European and U.S. stocks are highly correlated, but since October investors have helped U.S. stocks outperform Europe as the chart below shows.

SPY - S&P 500 ETF, VGK - Vanguard European ETF

It appears some investors believe the U.S. may be able to avoid much of the fallout should (when) sovereigns default in Europe.  I would feel a lot more confident in that thesis if more investors were actually buying stocks but volume has been in a steady decline and has started 2012 well below average.  When you compare the selling that took place in August with the buying that followed, it looks like many investors remain on the sidelines.

 SPY - S&P 500 ETF

Investors were reminded of the fragile U.S. economy last week with retail sales soft in December; it appears the U.S. economy doesn't have much of a tailwind as we move into 2012.

U.S. markets are closed on Monday, January 16, 2012, for the Martin Luther King holiday but Asian and European markets were open.  Singapore and Hong Kong closed down while Europe put a brighter face on developments, up as much as 1.25% in Germany.  Even our neighbors to the north took Friday's news in stride and close fractionally higher today.

It appears the near-term situation with Greece will be solved in one of two ways.  Either they will agree to the terms private Greek bond holders are willing to accept in their renegotiation efforts, which will likely only buy them more time, or they will default which could potentially lead them to reinstitute the drachma.

So far actions have been aimed at buying more time, so I expect Greece will be able to strike a deal with private bond holders over the next week or two.  Reuters reported today that Athens dispatched senior officials to Washington to consult the International Monetary Fund.  If another solutions is found it will likely come from someplace other than euro zone countries.  With others in the zone in need of help themselves, the pressure is on Greece to deliver on its structural reforms.

Only time will tell if U.S. markets continue to outperform.  Overall, individual investors may find high-quality U.S. bonds a safe haven while the latest Eurozone chapter unfolds.

After a sprint out the gate to start 2012, stocks sputtered across the finish line Friday despite a better than expected jobs number and an overall improving trend.  U.S. stocks delivered gains for the week:  Nasdaq rose 2.7%, S&P 500 1.6%, Dow 1.2%, and the NYSE 1.1%.  Leading stocks tracked by the IBD 50 rose 1.4%, suggesting smaller high-growth companies are not ready to lead the market.

Why the mute action on Friday?  The market is considering all aspects of job reports, including workers that no longer qualify for benefits or were not able to find a job to apply for in the last 4 weeks.  At least the market didn't plunge on the high unemployment reminder.

There has been some constructive action recently that may point to a continued rally.  Defensive industries (healthcare, utilities, consumer stables) are starting to lag while biotech, homebuilders and regional banks are starting to lead.

Internal stock market indicator are starting to firm on the bullish side.  A continued advance through the balance of January would be a very positive development.  International stocks, however, are having trouble mounting an advance.  International developed markets (EFA) declined -0.77% for the week while emerging markets (EEM) eked out a 0.74% gain. 

The challenges in Europe are front and center of every astute investors mind.  The situation is still very much a wild card in the global economic landscape. Fortunately 2008 was a good warm-up for financial crises management and recent maneuvering by monetary authorities has certainly bought time.  Investors would be well served to expect volatility through 2012 from developments in Europe.

The chart below is a look at how the investments held in the global growth strategies at Dightman Capital have started the year.  We still hold an overweight in U.S. bonds.  We removed our last international stock ETF back in August and spent much of the 3^rd and 4^th quarters defensively positioned.  We still hold a defensive dividend index, which was our first move back into stocks in Q4, but I expect it will be removed if the market strengthens which should drive our model to signal higher growth investment opportunities.

Click On Chart For Full View 

The mix is well positioned to capture some growth should stocks continue to rally but maintains an overweight in U.S. bonds. 

Next week investors prepare for the start of earnings season.  Analyst growth expectations have been drifting down for the 4^th quarter so numbers will be easier to hit.  Growth is expected to come in the high single or low double digit range.  The third quarter annual earnings growth rate was 16%.

After delivering about break-even performance for 2011, the S&P 500 is off to a strong start in 2012.  Unfortunately small U.S. company , international developed country, and emerging country stocks all suffered significant declines in 2011.  This will make it difficult for a traditional buy and hold portfolio to have performed well for the year.  I have suggested many times, this is not market for buy and hold growth investors.  U.S. bonds were a strong performer in 2011.

S&P 500 Stocks (SPY), Russell 2000 Stocks (IWM), Developed Country Stocks (EFA), Emerging Country Stocks (EEM), U.S. Bonds (AGG)

There was no shortage of news stories in 2011 to accompany the up and down action of the market.  Don't expect anything different in 2012.  The U.S. remains in a fragile slow growth economy and debt developments in Europe will likely continue to move markets.  Investors would also be wise to keep an eye on China as they address economic challenges.

One of the most difficult aspects of managing investments since the 2008 credit crisis has been saying positioned in growth assets.  I monitor a large set of global investments in a model that moved to a defensive mode over the summer of 2011.  As the year progress it started to move back into growth assets.  As we start 2012 my model has suggested our global growth strategy should hold approximately 60% in growth oriented investments.  Albeit, some of the growth investments recommended are of the more conservative type, including ETFs in defensive dividend paying stocks and real estate investment trusts.

I recently suggested the current environment is a lot like 2008.  Whether you look at headlines or investment performance, there is no denying the similarities. But markets are the ultimate arbitrator of the near-term future and right now they are signaling 2012 may start on decent footing.  My model could be back to defensive recommendations by the end of the month.  Earnings season starts next week which could change investor's sentiment in a hurry.  But as we have seen several times since 2008, stocks can rally for months before reversing course.  Other assets will also take turns trending higher in a market like this.  Bonds, gold and different industry groups all took turns leading the market in 2011.

This is not the market or economy of the 80's and 90's.  So the buy and hold strategy that worked so well during the sustained uptrend of those decades has found it tough going in the new century.  Eventually we will return to a more constructive market.   In the meantime, an active strategy designed to protect capital and position for profit is likely to fair better in the less constructive market and economy of today.

Are investors facing an environment eerily reminiscent of 2008?  The news out of Europe could easily be compared to U.S. housing and mortgage headlines in 2008 and the technical action of stock prices looks similar.  Is it possible we are entering a "here we go again" scenario?  If so, consider what may be shaping up.  We could be entering a period where investors can make new investments at bargain prices if markets fall further.

The overall technical picture remains mixed:

• some technical indicators have signaled a high probability of a sustained and severe market decline
• so far selling volume has been subdued since the August decline
• recovery rallies have followed the selling and in some cases on strong volume
• market leaders, often high-beta small-cap stocks, have also held up well

Overall the market remains biased to the downside and in some respects the technical picture for stocks is starting to look a lot like what we experienced in 2008.

What you are looking at in the chart below is the SPY (S&P 500 Index Fund) exchange traded fund over the last 6 months of 2011.  The blue line is the 50 day price moving average and the red line the 200 day price moving average.  The selling pressure over the summer was severe enough to cause the 50 day to fall below the 200 day, a very negative development.  As stocks tried to recover they ran into resistance along the 50 day (1).  Eventually SPY was able to move above the 50 day but now it is running into resistance at the 200 day moving average (2).

Now let's take a look at the first six months of 2008.  As investors entered the new year the 50 day was already below the 200 day and SPY was having trouble getting above it (1).  It eventually did but ran into resistance at the 200 day moving average (2). 

Most investors remember what the 4^th quarter of 2008 was like but for those that need a refresher the chart below is a continuation of the chart above.

Please note the charts are based on a logarithmic scale, which makes it hard to piece them together visually.  Below is a chart of the entire 2008 calendar year for SPY.  Most of the selling took place after the technical picture deteriorated.  I am not suggesting that it is a given that we are going to repeat the scenario in early 2012, but I am suggesting there is a high probability that stocks are going to fall much further from current levels and investors would be wise to prepare should it happen.

The economic data is not helping much either.  We have had some glimmers of hope, but other than a slight decline in unemployment claims there is sparse evidence of robust economic growth.

When the skies clear, and eventually they will, there are going to be some terrific buying opportunities for nimble investors.  Even if markets stabilize and start to advance in 2012, look at some of the opportunities already shaping up.

• India (EPI) - Down 39% YTD
• Metals & Mining Stocks (XME) - Down 29% YTD
• Brazil (EWZ) - Down 27% YTD
• China (FXI) - Down 21% YTD
• International Real Estate (RWX) - Down 18% YTD
• Agriculture Stocks (MOO) - Down 15% YTD

In the meantime there are defensive moves for investors to consider.  If you want to hold stocks in your portfolio consider sectors like Utilities, Healthcare and Staples.  I would also keep my exposure to a fraction of what I would own under more favorable conditions.  Bonds are a good place for uncertain markets but I would keep maturities in the short to intermediate term and be ready to deal with a rising interest rate environment should it develop.  The key with bonds is liquidity.  Growth investors will want to move out of bonds and into stock investments when a good opportunity arrives.  Of course there is always cash.

The name of the game right now is preservation of capital so you have it to deploy at a more opportune time.  To know when the time has arrived, stay alert to market and investments by monitoring them often.  You don't need to buy at the bottom, but if you can avoid most of the market declines and reinvest when markets have started their recovery, you may be able to make a lot of money in this environment.

The fabric of the EMU is seriously frayed and could tear.  Volatility in global stocks has been very high recently signaling uncertainty by investors.  In additional to the European debt issues, the U.S. Super Committee results and the woefully slow and potentially recessionary U.S. economy are difficult issues for investors to overcome and feel confident about deploying capital.  This is evident in the below average volume accompanying the current rally attempts.

There is still time to take defensive action if the environment turns into a sustained market decline.  Here are a few ideas to consider.

In terms of stock exposure, lighten up your allocation across the board.  For the exposure you maintain consider dividend paying investments from defensive industries like utilities and healthcare.

A small allocation to precious metals may make sense.  It can be volatile but the asset class has come off of highs hit late this summer and offers a diversification benefit.

U.S. investment grade bonds are also worthy of consideration.  The potential for capital gains from the asset class is limited with yields at such low levels.  I like bond investments that make interest payments monthly.  I suggest using a strategy that keeps interest rate sensitivity reasonable and make sure you have an ability to exit quickly or hedge a rising rate environment should it develop.  The horizon for interest rates looks fairly stable in the near term but can change quickly and investors should be prepared.

 Hold cash and cash equivalents.  Once the environment improves you will have capital to deploy.

I have advocated an emphasis on risk management in this type of market environment.  Devastating declines to your capital make it difficult to generate positive compounding when conditions improve.  When a better environment arrives, the more capital you have the more growth you can experience. 

Earlier this month I reported the Economic Cycle Research Institute (ECRI) issued a recession warning.  It is important to understand that even back in 2008 when ECRI issued a warning, markets and some economic data improved for a period of time.  They manage leading economic indicators and ultimately the economy contracted and the stock market experienced a significant decline.  You may find it valuable to review their 2008 recession call video.  It helps to illustrate that market and general economic data can miss the onset of a recession.

As you probably know, I have taken the position that we are in a secular bear market that started back in 2000.  Secular bear markets are periods that are impacted by structural challenges in the economy that take long periods (around a decade, sometimes two or more) to work through.  The two most obvious current structural economic challenges in the U.S. economy are high debt levels and a large number of workers nearing retirement.

For those investors that have held an investment of the S&P 500 since 2000, it has been quite a roller coaster ride.  Today they are still below highs hit in 2000, over 11 years later.

One of the first things I recognized when I started managing money in 2002 was that the environment investors experienced in the 80's and 90's was not likely to continue.

This led me to seek investments and strategies that would potentially moderate volatility and avoid sustained downward moves in stock prices.  My current model is based on changes over months/quarters not weeks/months.  I understand this is an incredibly frustrating environment but I want to remind clients that it is also a volatile time.  That does not mean there are not opportunities to make money but our primary focus in this type of environment is to attempt to avoid sustained downward moves in asset prices.  If a recession follows, the likelihood stock prices will be hit hard is high.

One of the more recent celebrated economic releases focused on a stronger than expected GDP report, a backward looking data point.  While the top line number was stronger than expected, after digging into the details we learn that it was largely attributed to consumer spending.  Normally that is good news, however this spending was based on utility and healthcare expenditures, considered necessities, which are generally not associated with widespread economic growth.  You can find more in Lance Roberts' recent article where he dissects the most recent report.

Some commentators are marketing messages such as "Best Recession Ever" or "Don't Fear the Volatile Market" in recent reports.  Before you subscribe to this thinking I would encourage you to investigate their track record.  For example, what was their position and how well did they protect clients in the 2008 market decline?

When you look at the data over very long periods the U.S. stock market spends the vast majority of the time rising.  Only a small percentage of the time is it declining.  Therefore, you can be bullish commentator all the time and be consider "Right" more often than "Wrong", despite the damage inflicted on investors when stocks fall by 50%.  Eventually this bear market will run its course and a bull market will return.  Until then, I believe clients will be best served with an emphasis on risk management and patience.  It might also be helpful to view the two charts above one more time and read this short comparison of bear markets.

Trading for our strategies at Dightman Capital has picked up the over the past several weeks and an enhancement to our approach has been the emphasis of client communications recently.  We also sent a note to clients about deteriorating forward looking economic indicators.  Overall strategies at Dightman Capital have been preparing for a deteriorating environment for weeks and now consist of primarily defensive positions.

While there has been some strength in select economic data, overall activity has not been able to bring unemployment below the elevated level of 9%.  Adam Smith described Land, Labor and Capital as the factors of production that produce utility and wealth.  I believe our political leaders are going to have to address how each area is being handled and propose more productive solutions.

Perhaps we will avoid a sustained move down, but the risks we won't are high.  I know some readers may wonder how the market could go so low when stocks are considered by some to be so cheap.  What investors often forget is many P/E calculations are based on FORECASTED earnings, which are often revised down, sometimes dramatically, as economic conditions deteriorate.  Be on the lookout for this development as we enter earnings season in October.

I prefer to use adjusted historical earnings based on Shiller and Crestmont methods to gauge whether stocks are cheap or expenses.  The most recent data show they are a little more than fairly valued.  The most recent update from Crestmont puts the average Crestmont adjusted P/E ratio at 13.7.  As of September 30^th the Crestmont P/E ratio was 16.8, above its historical average (arithmetic mean).  The trouble is many other factors like the price of S&P 500 and Corporate Earnings Growth are also above their historical averages.  Is the perfect fundamental storm about to unleash capital destruction on investors?  I sure hope not but here again is reason for investors to be cautions.

So what is an investor to do now?  If you believe we are about to enter a period of a sustained downward move in U.S. stocks, investment grade bonds are a logical choice.  I know some commentators consider bonds in a bubble and risks in the asset class high.  With the U.S, economy heading into recessionary territory, inflation and interest rates are likely to be held at bay.  Japan is a current day example of a developed economy that has been able to keep interest rates low for a prolonged period.

 I do expect U.S. stimulus measures will eventually catch up to us in the form of inflation and higher interest rates which would push bond prices down.  That is why investors might consider using bond ETFs for exposure to the asset class.  There are several bond ETFs with better liquidity than some individual bonds which may allow an investor to trade the investment more efficiently.  You also get the benefit of diversification.  With just a few bond ETFs you can cover several different classes of bonds across the yield curve.  That is more difficult to do with individual bonds.

Another strategy for dealing with rising interest rates, when the day arrives, involves shorting the bond market.  There are several ETFs available today that would allow an investor to hedge their bond portfolio should rates start to rise.

If you believe bond interest rates can move lower bonds are a reasonable place to invest during a downward move in stocks.  You have the potential for capital gain and you also collect income along the way.  With money markets not paying investors, there are few viable places to park cash while you wait for the current situation to stabilize and recover.

There are a lot of mixed signals in the economy right now.  When the message gets muddy, that is when it pays to play more defense.  Regardless of what happens over the next few weeks or months, the economies of developed countries are in serious trouble and likely to keep markets volatile for years.  Sure, we can issue trillions in additional debt to prevent defaults, but the debt has to be repaid.  The simple fact of the matter is some economies are not growing fast enough to make payments on their EXISTING debt.  How do we expect they will be able to make payments on additional debt?  So far budget cuts and austerity measures have not been enough, especially with the low growth economy. 

Michael Lewis has a new book, Boomerang, which surveys some of the world's most financially challenged countries.  He recently provided a nice overview of how several countries created their debt trap and how they are responding.  The contrast between the Icelandic, Irish and the Greeks reveals how difficult it can be to bring different cultures together and helps explain some of the challenges Eurozone policy makers face.  You can listen and read the story here.

Back in the U.S. we have our own set of challenges.  We find ourselves at the convergence of both systemic economic issues (aging populations and high debt levels) and mixed policy effectiveness from our elected officials.  The economy is facing multiple challenges that are not often experienced or understood completely and standard Keynesian economic policy appears to have fallen short of what is needed.

The bearish tone of the market has been augmented by a recent announcement from the leading economic indicator firm, Economic Cycle Research Institute (ECRI).  They have made a recession call for the U.S. which is explained further in this video clip.

This is not the economy of the 80's and 90's which is why I have been urging investors investors to use a different investment approach.  An approach that is more nimble and active.  We recently enhanced our strategy after a period of backtesting and implemented the change at the end of September.   It will take a couple of quarters to confirm our expectations.  We believe we will be able to maintain our current risk management element, which is simply the goal of avoiding sustained downward moves, with the enhanced characteristic of positive annual returns.  It is a tall order but our experience with this economy and new backtested data we are ready to take on the challenge.