After a tremendous rally from lows hit in March, stock investors want to know if the rally will continue into 2010.  Leading economic indicators produced by the private firm, Economic Cycle Research Institute (ECRI), suggest the economic expansion that started in the 2^nd quarter of 2009 will continue well into 2010.  Their most recent comments suggest an improved job market may only be a few months away.  We won't have to wait long for clues, several employment reports will be released in the first full week of January.

An improved job market could be a near-term catalyst to help stocks move to higher ground.  But don't expect unemployment back in the 5-7% range anytime soon.  If economic growth brings unemployment down by half a percentage point per year, a figure used by Lakshman Achuthan of ECRI as historically relevant going back many decades, strong employment numbers will not be reached until 2020.  With the U.S. economy growing more slowly in recent decades, a lower unemployment number may be elusive for an even longer period of time. 

Structural changes in the job market have seen some manufacturing jobs permanently eliminated, jobs that will not come back in a recovery, largely due to productivity increases.  If productivity growth is higher than demand growth, the imbalance results in job losses unless structural changes are made to the employment market.  Ironically, all the political talk about health care cost being too much of our GDP is exactly wrong under this scenario.  Yes, we want our health care dollars to go as far as possible but for long-term replacement of manufacturing jobs industries like healthcare, education, and finance are logical areas for private market job expansion.

Lakshman expects more frequent recessions in the coming decade than we saw in the last two or three.   Part of the reason has to do with the difficulty in smoothly withdrawing stimulus funds.  If they are pulled back to quickly we could fall into another recession; to slowly and surging inflation may develop.

The business cycle expansion that started in Q2 2009 appears firmly rooted to carry us into at least the first half of 2010.  This should bode well for stocks, but after an amazing run from 2009 lows it is difficult to gage how much more upside they may produce.  Most of the rally took place before October.  From March 9^th through September 30^th the S&P 500 gained 56%.  From September 30^th through December 21^st it has gained only 5.4%.  It looks like the S&P 500 will be up around 25% for 2009.  The market consolidation over the last few months may ultimately turn out to be just what the market needs before moving higher in 2010.

As we close out 2009 another shift appears underway.  After declining most of the year the U.S. dollar staged a sharp rally in December, up over 4%.  Surprisingly the S&P 500 delivered gains (they have been inversely correlation since March) for the month but international stocks struggled.  Both developed country and emerging market stocks show small declines.  A strong dollar is often bearish for U.S. stocks.  There are many inputs at work in the markets and as Wilbur Ross said recently on CNBC, "Now that the value of information has gotten to be about zero, there's an overload, and I think what's gonna be the end result is the value of expertise is gonna go to infinity.  Because it is harder and harder for people to digest all these inputs, let alone make sense out of them, let alone translate them into investment decisions."

CLICK IMAGE FOR FULL VIEW

I remain cautiously optimistic about stock returns in the first half of 2010.  The action of leading stocks has improved somewhat in December which improves the likelihood stocks will break out of the current trading range.  I believe deflation has moved off the table for the time being and inflation is generally contained.  At present stock investors appear willing to discount ongoing credit market issues and place more emphasis on somewhat improved economic measurements.  

All of this is subject to change depending on fiscal and monetary policy action, not to mention potential credit market surprises.  For now we can be grateful for the gains the market presented us with in 2009; Dightman Capital in on track to produce a very strong year for all three of our growth strategies.

Have a Wonderful New Year!

After easily topping low Q3 earnings expectations, stocks are finding it difficult to advance from highs reached in October.  Hesitation may be coming from new reports of continued struggles in the housing market where mortgage delinquencies continue to rise and new construction has slowed.

The credit market continues to remains tight and while problems in the commercial real estate market percolate.  Commercial borrowers are finding it difficult to refinance loans and recent regulatory guidelines make it easier for banks to extend terms on many properties, potentially delaying foreclosures.  Banks are also hesitant to foreclose on troubled properties because selling at current prices would require write-downs they don't want to realize.  The key for commercial borrowers is leasing revenue, a function of lease prices and occupancy rates.  As long as borrowers have the cash flow to continue servicing loans the market should remain somewhat stable but defaults have been rising as vacancies increase and rents fall.

As the economic recovery continues to unfold we can see how the performance of banks, commercial real estate, and home builders has transitioned from leading the market to lagging the market, possibly offering a sign of caution as we enter 2010. 

The first chart below shows all three groups leading the S&P 500 from market lows in March up through the middle of October.  Over the last month the tide has shifted.  Commercial REITs have fallen to just match the performance of the S&P 500 and Banks and Builders are lagging by a significant margin.

NOTE: CLICK ON IMAGES FOR FULL VIEW

Given the role real estate and banking played in the market selloff in 2008 we would expect them to play a leading role if markets are going to advance from current levels.

We have also seen a shift in stock leadership.  As the November rally kicked off the Dow Jones Industrial index has outpaced the S&P 500 potentially signaling a shift to larger, more stable companies.  The transportation index has lagged as have small cap stocks, another disappointing development.

The balance of 2009 may see a continued rally in stocks as we enter into the holiday season, often credited with what has been called the "Santa Claus Rally", but the clouds may be forming for what could turn out to be very challenging start for stocks in 2010 unless more fundimental improvement of the economy is reported.

If you have been participating in my recent monthly online strategy updates (you can register for the next webinar here), you have heard me talk about secular and cyclical markets.  If you are wondering what this means, I offer the following insight.

There is much debate on the subject and no definitive definition that I am aware of on the subject of secular markets.  To use an analogy, I would compare the seasons of a year as secular and the weather patterns within each of those seasons as cyclical.  Starting with a hot summer season you progress to a cold winter before heading back to a hot summer (secular), but throughout this major transition you have many short term temperature variations (cyclical).  Some summers are unseasonably cold and the opposite can be true for winters.  With economies and stock markets, think of the secular time frame as years/decades and the cyclical timeframe as quarters/years.

Secular markets are created from deeply rooted structural characteristics in an economy.  I believe among other things, household debt, government fiscal condition (at all levels), and an aging population are a few examples of the structural characteristics of the current secular bear market in U.S. stocks.

Cyclical markets are predominantly influenced by the business cycle experiencing its own expansion and contraction within the secular environment.  I believe the business cycle process is largely autonomous but can be influenced by government actions (interest rates, tax policy, stimulus, etc.).  The business cycle is the natural ecosystem of capitalism at work where, as a simple example, businesses grow during periods of growth, over expand, start to struggle and are then forced to downsize, merge or go out of business.

The best example of a modern day secular bear market can be seen in Japan, the world's second largest economy.  On New Year's Eve in 1989 the Nikkei 225 Index of Japanese stocks peaked at 38,915.  Approximately 20 years later, it closed at 10,443, down over 70% from its peak as illustrated in the chart below.

Turning to the U.S., stocks have experienced big swings in value over the last ten years but have not been able to advance past the highs reached in 2000.

I try to approach the process of managing money from a risk management perspective that considers both the secular and cyclical environments.  Right now I view the current environment as a secular bear, cyclical bull market.  That means I am willing to position my strategies to make money in the near term, but ready to move defensively if I believe the rally has run its course and new trend down has started.  Among other things, I believe household debt levels will need to be reduced, government finances will need to be improved, and lower U.S. consumptions levels (assuming higher saving rates materialize) will need to be replaced with higher consumption levels by foreigners before we can transition to a secular bull market.

Once we finally transition back to a secular bull market we should see long periods of stock market appreciation.  From 1982 to 1999 the S&P 500 appreciated an eye popping 1,048% over 17 years.  If we added in dividends it would be even higher!

I hope you found this information helpful.  If you have any questions, feel free to let me know and I will do my best to answer them.

The rally that started mid-July looked like it was about to end only a month later.  On Monday, August 17^th, continued selling from the Friday before looked like the start of a correction.  The S&P 500 was down 3.26% during the period on consecutive increases in volume.  By the end of the week, however, the market reversed course again hitting new highs for the year on above average volume (which was subject to August options expiration).  Since then the market has not been able to follow-through and trading looks weak.  But the breakout last Friday was impressive and the bias for the time being is to the upside.

In terms of sector performance, Financials continued to lead but Technology underperformed and Consumer Discretionary came in just below the S&P 500 over the last 5 trading days.  The S&P 500 is represented as the horizontal 0 baseline.  Returns above the centerline have outperformed and those below have underperformed the S&P 500 during the period.

CLICK ON THE CHART TO ENLARGE

In terms of major U.S. markets, small cap companies have led over the last 5 days and the NASDAQ has underperformed the S&P 500.

CLICK ON THE CHART TO ENLARGE

Internationally, Germany and France are leading and significantly outperforming the S&P 500.

CLICK ON THE CHART TO ENLARGE

Stocks are overbought and could correct at anytime, but the likelihood there is more upside is very good over the months and quarters that follow.

Just as stocks looked like they were going to move to the downside after a consolidation period in June and early July, stocks made a strong advance to the upside last week.   On July 13 the S&P 500 advanced 2.5%; one of its strongest days in weeks.  The following day the IBD 100 experienced its' fourth straight day of gains, up 1.2%.  Big money (institutional investors) showed up on the 15th and pushed volume higher by roughly 40% from the previous day's level on one of the best days of the year for major stock indexes.  The upside move by stocks coincides nicely with leading economic indicators produced by ERCI.  The growth rate of their Weekly Leading Indicator for the U.S. has been improving for weeks and recently moved into positive territory.

With a major change in market character, this would be a good time to review how different investments are performing.  Below I have listed the performance over the last 5 days (as of the close July 20th) of the ETFs currently held in accounts managed by Dightman Capital (see disclosure below).

• AAXJ - Asia Ex. Japan (17.64%)
• FGD - Global Select Dividend (14.66%)
• EEM - Emerging Markets (11.66%)
• BRF - Brazil Small Cap (10.45%)
• HAO - China Small Cap (10.23%
• QTEC - Technology (9.57%)
• DBO - Oil Fund (9.17%)
• QQQQ - Nasdaq 100 (6.55%)
• SPY - S&P 500 (5.58%) Index Reference

Some of these ETFs have been recently added to my strategies and several were added earlier this year.  For a more complete look at the performance of our strategies, please review our Composite Performance published on June 30^th.

The change in stock market character signals, in my opinion, the potential for a more constructive market environment for stock related investments in the near term.  I am still overweight cash in my strategies but could become fully invested very quickly.  With the improved action in stock markets combined with an improving economic environment, the likelihood we will move into a bull market increases.  What you really need to know is what kind of bull market I am talking about.

I view bull and bear markets as cyclical or secular in nature.  A secular market is considered one that is being driven by forces that could be in place for years.  Within a secular market you will have cyclical markets associated with the expansion and contraction of the business cycle as well as changes in investor sentiment.  It is my opinion the current secular state of the market is bearish.  Viewed from a longer time period, broad indexes are trading today at the same level they were in the late 1990's.  Stock indexes will need to appreciate considerably from current levels to move into secular bull market status. 

Starting in the early 1980's, U.S. investors experienced two decades of a secular bull market with brief cyclical bear markets.  This period marked one of the most significant advances in stock market history, which ended in early 2000.  Since then the S&P 500 has not been able to advance beyond highs hit in 2000 and has experienced two brutal bear market declines.  Within the current secular bear market, evidence is mounting that we started a cyclical bull market back in March.  It could transition to a secular bull market but for now we need to use a shorter time frame and treat the current rally as cyclical in nature, in my opinion. Investors face many structural challenges that may prevent our economy from producing a transition from a secular bear to a secular bull market in the near term.  I have written about some of these structural challenges in the past and will continue to share my opinion on the subject in the future.  I believe keeping an eye on business cycle metrics as well as market price and volume action may prove to be especially helpful in the current environment.

For the moment it looks like stocks are poised to continue generating gains, led by emerging market countries and technology.  Below is a chart of sector performance since the start of the consolidation phase (start of June through July 20^th) which shows the technology sector leading.  This has been true of the broader indexes as well.  From the March lows the Nasdaq, with a higher concentration of information technology companies, is up 50% while the S&P is up 40%.

Click on image for full view. 

Nobody knows how long this cyclical bull market may last.  I do believe I have the tools and processes necessary to monitor market and business cycle activity in an effort to manage my strategies.  I am of the mind that we are in a cyclical bull market within a secular bear market.  With that in mind, when/if this cyclical bull market ends, there might be prudent defensive action to initiate.  If this is a risk management technique you would like applied to your investments, let me know, I would enjoy learing more about your investment management needs.

Disclosure:  Strategies managed at Dightman Capital are currently invested in AAXJ, FGD, EEM, BRF, HAO, QTEC, DBO, QQQQ.  This is not a complete list of all investments in the strategies managed by Dightman Capital.

More evidence of an improved economic environment was delivered last week when ECRI announced the growth rate of their leading economic indicator for the U.S. broke into positive territory delivering the highest weekly growth reading since August 10th, 2007. You can read their entire press release here.

Stocks ended the 2^nd quarter of 2009 stuck in a trading range that marked most of the action in May and June. Overall trading has been constructive; marked by higher highs and higher lows.  Still, volume has been down on price advances, possibly indicating uncertainty by traders where there should be strength.

Individual stock leadership (as measured by Investor's Business Daily indexes) improved as the rally from March progressed, a promising development.

As long as SPY (S&P500 ETF) can hold above $87.50, the market rally will likely remain intact.  The NASDAQ 100 (QQQQ) has shown relative strength during the current rally and small caps (IWM), to a lesser degree.

The Consumer Discretionary group (XLY) has hit support at $22 three times since May.  Failure to hold this level may signal the start of a correction.

Selling pressure that materialized in June caused little damage to stocks overall.  End of quarter window dressing by fund managers and low summertime volumes created some noise in the market, but overall stocks appear fairly healthy.  Earnings over the next several weeks may provide stocks the catalyst they need for a move higher or lower.

The rally from March lows has been impressive.  There are few reasons to add new positions while stocks remain in this trading range, in my opinion. If stocks break out higher (above $95 for SPY) or fall below support it may be a good time to add new positions.  In terms of downside targets, I would not expect March lows to be hit or broken.  I do believe a market correction would be healthy given the magnitude of gains that were created over the last few months.  If the S&P 500 breaks May support at 880, using a Fibonanci Retracement Tool from the March lows to the June highs would suggest a pullback to 845, followed by 813 and 781 depending on the selling intensity.  If you are looking to enter new positions based on a pullback, watch the index action at these levels.

Enjoy your 4^th of July holiday weekend!

As the pattern of global economic data of less negative numbers continues, a shift may be taking place in asset pricing.  Two possible reasons among many:

1)  Asset prices are taking a break from the rapid appreciation realized since March

2)  Economic data needs to move from less negative to positive as a catalyst for continued appreciation from current levels 

 In terms of asset prices, most of the month of June has been spent consolidating.  Consolidation is a normal process and can be very bullish.  Unfortunately, market action recently has led to price declines.  My first course of action is to try and gauge whether we are going to experience a normal pullback or something more aggressive.

Commodity markets were a big part of the rally from March lows.  Due to their sensitivity to the U.S. Dollar, we might be able to find near term price clues by comparing the two assets.

In the Chart below, the top window shows the daily price for the U.S. Dollar reversing up after the decline that started in mid-April.   The bottom window shows the relative strength ratio between broad commodities (Powershares DB Commodity Index, DBC) and the U.S. Dollar ($USD).  An upward sloping line indicates the first symbol is stronger than the second.  The trend turned flat in early June and has a slight downward bias.  A move past $82 on the U.S. Dollar may signal further weakness in commodities.  So far oil has been able to hold most of its recent gains but strength in the dollar would be negative for crude oil prices.

(CLICK ON IMAGE FOR FULL VIEW) 

After a strong start to the month stocks have started to rollover.  The nearly 4% decline since Friday in the S&P 500 has already put the index in oversold condition (as indicated by the reading below 30 in the lower window of the chart below), which could signal a near term bounce ahead.  For a clue regarding the strength of the bounce, we can turn to the Relative Strength Indicator (RSI) in the bottom window of the chart below.  The key will be how the indicator behaves around 50.  Any weakness at this level may indicate further price pressure on U.S. stocks.  A move past 50 on the RSI would be bullish for the S&P 500.

(CLICK ON IMAGE FOR FULL VIEW)  

For additional cues about the strength or weakness of any bounce from current levels, consult breadth indicators, volume levels and sector participation data.

You might be wondering how international stocks are doing.  They were very strong and led the rally from March lows with gains in emerging markets of approximately 54.9%, developed international markets 45.6% and 35.5% for the S&P 500 as illustrated below.

(CLICK ON IMAGE FOR FULL VIEW)  

More recently, however, they are also leading the declines.

(CLICK ON IMAGE FOR FULL VIEW)  

Of note is how China is handling the current weakness.  It has held up better than many other emerging markets; an important development to monitor.

(CLICK ON IMAGE FOR FULL VIEW)  

We may be in the early stages of a market transition.  Continued strength in the dollar would be bearish for commodities and techical data on stocks may help us gauge near term market direction.  Continued leadership from China would be very constructive for that market.

We are well into Q1 earnings season; overall earnings are down about 35% but many firms are beating lowered targets.  We are also starting to see forward guidance improve, a signal to some the worst may be behind us.  So far it appears cost cutting has adequately cushioned revenue declines for many U.S. corporations. 

Earnings Data as of Friday, May 5^th:

•                 65% of S&P 500 companies have reported
•                 Two-thirds have beaten low expectations vs. one-quarter that have fallen short
•                 S&P 500 firms collectively are beating targets by 10.4%
•                 S&P is expecting a 20% drop in earnings next quarter
•                 Healthcare was the only sector to report positive earnings growth

Data provided by Investors Business Daily. 

The market likes the results.  The S&P 500 bolted 9.7% during April on top of an 8.5% gain in March.

Cost cutting alone, however, may not be enough to sustain the improved environment.  Eventually the year-over-year earnings comparisons will become harder to improve upon without revenue growth.

Evidence the economic contraction is slowing has added fuel to the rally.  A weekly measure of future U.S. economic growth moved up to a 13-week high.  The annualized growth rate also continues to improve prompting Lakshman Achuthan, Managing Director for ECRI, to declare "...an end to the U.S. recession is now in clear sight."  He expects the U.S. economy to emerge from the recession later this summer.

A slowdown in the economic contraction along with a somewhat improved earnings environment has contributed to the rally in a wide range of asset classes.  The real test for the S&P 500 will come when it reaches its January high of 934.  The NASDAQ had no trouble passing this milestone back in early April.

Leading stocks are slowly starting to deliver as well.  Last week the IBD 100 (fundamentally strong but younger and smaller companies) outperformed other indexes, a characteristic need for a sustained rally.  Other post-contraction stock market up trends in '32, '38, '75, & 2002 also showed solid and tenacious leaders were slower to emerge.

I would suggest this is going to be a dicey week for stocks since the bank stress test results will be released.  Then again, since some stress test information has already been "leaked" without inflicting much damage, Thursday's announcement may have little impact. It is no surprise many banks are expected to need additional capital.  What will be interesting is how the banks are ranked, what the total capital shortfall amounts to, and how the troubled banks address their capital shortfalls.  All this while the government is authoring a regulatory change that will allow it to take over, and if necessary close, financial firms that have become "to big to fail".  All this may suggest the final chapter in the credit crisis recession is still being written.

Other challenges remain with company valuations and trading volume. Current valuations tend to fall in the fair or expensive range when compared to bear market bottoms in the last 100 years.  Stocks don't have to hit the lowest bear market valuation levels before recovering, but given the systemic nature of the current recession, it is reasonable to expect valuations to fall toward the lower end of the range.  For more detail on the subject see the following commentary by William Hester of Hussman Funds.  Lower valuations are not a requirement for a sustained rally, but they would lower the risk of the current rally becoming a bear market rally.

Every recession and bear market has its own character.  This will not be the first time trading volume arrived late to the party.  Near term, few market observers would deny it will be important for trading volume to increase if we expect the current rally to continue.

Given the amount of government market intervention and the less dismal economic and earnings reports that have sparked this rally, stock prices may have gotten ahead of themselves over the last couple of months.  Don't be surprised if this turns out to be a "sell in May and go away" month.  Then again, if volume picks up and the market continues to advance, the odds increase that the lows of this bear market are behind us. 

If you have tip-toed back into the market over the last few months you should be sitting on some nice gains.  At this juncture I am inclined to wait for a pullback or consolidation before committing more funds.  If you are afraid the market is going to get away from you, consider concentrating on those markets that have exceeded their January highs.  I would suggest entering partial positions slowly, that way you can add to positions that are outperforming, look for new leaders, and take advantage of lower prices if a pullback develops.

This week's trading ended a day early and with strong action marking the 5^th consecutive week of gains.  U.S. stock markets will be closed tomorrow for Good Friday. 

While I still have doubts about the sustainability of the current market advance, several characteristics offer enough evidence of near term strength for me to start putting some money to work in new stock investments.  I find market observation a fascinating activity; a few of the characteristics in this rally that led me to make new investments include the following:

• Investment Grade & Below Investment Grade Corporate Bond Yields Continue To Narrow 
• Leading Economic Indicators Continue To Stabilize
• Market Technical's Have Improved
• Some Individual Stock Leadership Is Developing
• Stock Market Prices Are At 2003 Levels

I would not be surprised if we come back from the Good Friday & Easter weekend to a lull or even a pullback in the current advance.  Another correction to March lows or beyond is still a real possibility.  There are plenty of reasons to wonder if this rally is for real, but the farther we move from recent lows the less likely we are to hit them again, in my opinion.

Regarding broad stock market analysis, all votes are ultimately cast in daily buying and selling.  Despite what a reporter, analyst or economist says, you can tell what investors are actually doing by how the market behaves.  Today we had another big price advance on strong volume, a trend that started with the advance that began on March 10^th.  By my count, here's the ratio of daily price advances versus declines on above average volume since the rally kicked of March 10^th (23 Trading Days):

• NYSE                      10:2
• NASDAQ                   8:2
• S&P 500                  10:3
• DJ 30                        9:3

My new investments include a broad U.S. index with a concentration in the technology industry, a global dividend index with its largest allocations to Australia, Canada, Sweden & the U.S, which at present are some of the top performing developed countries, and international exposure to emerging markets, another area of strength.

Economic uncertainty remains and volatility could return to the market, but all things considered it appears a reasonably good time to put some cash back to work in global stocks.

I stand ready to deploy additional capital should prices retreat or advance.  I do not expect this market to return to a "bull market" for some time and will continue to use a variety of techniques to generate returns and moderate volatility.  As I deploy more capital in my strategies, it is a good time for new clients to come on board.  If you have thought about using my services in the past, now is an excellent time to let me know.  Happy Easter egg hunting!

Markets made the most of the details released Monday on how the government plans to deal with toxic debt at banks.  The new information helped continue the rally started March 9th.  The action overall, however, is suspect.  Consider the following:

• The rally was touched off with partial quarter reports by Citigroup, JP Morgan and BofA saying they were profitable in the first two months of the year. Gee, we only have to wait another month to find out what happens to their profit after they factor in write-downs and other costs over a full quarter.
• This was followed by The Fed announcing a huge quantitative easing program which may offer some short term benefits but has very negative long term costs.  The same day the dollar took a dive and prices for several inflation sensitive asset rose.
• Monday morning Treasury Secretary Geithner announced his private-public toxic debt plan.  Let me see if I get this right.  The government wants investors to buy bonds that a judge can modify (Home Affordability Act - an unintended consequence?) using cheap financing and 6 to 1 leverage (characteristics of what got us in this mess).  The market was thrilled to at least have a Plan A and perhaps it will help banks clean up their balance sheets.
• There was little stock leadership in the rally, mostly very depressed stocks (many big financials) coming up from very low prices.  This does not bode well for sustainability.
• The bond market does not seem to be as euphoric.  Interest rate spreads on bonds issued by financial companies tracked by Merrill Lynch have only narrowed slightly from the high they hit on March 11^th.  The bond market seems to be reserving judgment on partial quarter profits and toxic debt recovery plans.

In my opinion, these along with many other characteristics, call this market advance into question. 

In terms of economic news, we have received the first signs that the U.S. economic contraction may be stabilizing.  ECRI reported some improvements in the housing market, among other developments, contributed to a stabilizing of their leading U.S. economic growth indictor.  This is a potentially positive development but will require confirmation in the weeks that follow.

Regarding how we could solve the toxic debt problem in other ways.  One idea that has been suggested is to nationalize insolvent banks and transfer their operations to regional banks that are in better fiscal shape.  This action would severely impact the capital structure of the insolvent banks and may send massive ripples through the global financial system.  It would probably require coordination with monetary authorities in other countries.  It is entirely possible that a Plan B of this sort is in the works.  Congress is already considering non-bank takeover power of financial companies.  What is surprising to me is how long it is taking the government to address the severity of the problem and a willingness to come clean about what it is going to take to fix it.

The risk in Geithner's plan is that asset sellers (banks) and buyers (institutional investors) will not be able to agree on price, even with the incentives offered to buyers and the government arm twisting sellers, so few transactions will actually result.  Banks will continue to hoard their capital and the much needed stimulus to constructive lending will be non-existent.  I am also surprised by the degree to which our government has rewarded the management of institutions that managed risk so poorly.  Since when is failure not an option?  In cases like this we want failure to be orderly, but at some point we have to recognize the losses (unless we can continue to defer it).

With Medicare, Social Security, deficits and national debt, it is difficult not to be disturbed by the path our government has taken.  I don't even want to think about what the future will hold if the plans being unveiled, and there is little room for error, fail and they don't have a Plan B.

The Obama presidency is off and running and since taking office I believe the administration has provided enough details to help me position my near-term strategy.

By most accounts, the United States has systemic problems in its economy that have been building for decades.  There's not been a day that has gone by in the past year with a news report or a commentary reminding us that American's individual spending habits are beyond their means, or government spending policies are flawed. Understanding how our current economic problems are going to be addressed near term, as well as the list of priorities the new administration is committed to, has led me to formulated the following investment themes.

I believe the likelihood we are going to see declines in stock prices from these already low levels is high for two simple reasons.  The first is consumer spending, which represents approximately 70% of our economy.  It has declined and is likely to continue doing so as unemployment trends higher and those still working focus on paying off debt and saving.  The stimulus spending the government has initiated will fill some of the void left by consumers but overall it represents about 5% of our GDP and will be spent over more than one year.  (Stimulus Spending = $787 Billion/ U.S.  GDP = $14.6 Trillion)  The second reason involves residential real estate which is forecasted to experience a high foreclosure rate for the foreseeable future which will continue to put pressure on credit markets, even if real estate prices stabilize.  The plan to help distressed homeowners may bring some relief to the residential real estate market, but I expect it will have limited utility.

Some industries may be able to produce positive results in 2009 but so far those that seem well positioned because of the administration's priorities, such as a push to alternative wind, solar and other clean energy sources, as well as environmental services and infrastructure groups, have not yet been able to separate themselves from the broader market selloff.  As a matter of fact, most of these groups have lost significantly more than the S&P 500 during the last six months.  Some of these groups may lead the next rally, but at present they are not doing so.  Other industry groups I am watching closely include those tied to commodities, especially those in energy markets and materials.  On the international front, some emerging market countries may be able to recover more quickly.  Those countries with abundant natural resources as well as a strong fiscal position may become good candidates for portfolios in the future, but I believe it is too early to take positions.

In terms of our government's effort to prop up our banking system, it is an incredibly complicated situation.  I am in support of letting some fail, which has happened and will likely continue, but a wholesale collapse of the system should be avoided.  What has become clear is this; all of the bailout programs along with stimulus spending are going to cause our deficit to shoot up by an estimated $1.8 Trillion in 2009 followed by many more years of potentially huge deficit spending.  This will require our Treasury to issue bonds at an alarming rate.  It will be worth watching the Treasury to see if they are able to continue issuing debt at low interest rates.  The Fed has shown a willingness to expand its balance sheet, so we know they can help support a low interest rate policy but I feel like this may hamstring the Fed's ability to continue with their quantitative easing policy.

At present my strategies are very defensively positioned and I expect they will remain that way most of this year.  However, if there are limited opportunities to have a positive effect on strategy returns, I believe they should be considered.

This brings me to my first investment theme.  Near term, one of the few debt markets where you can receive a reasonable interest rate is corporate bonds.  By example, 10 year Treasury bonds are currently paying less than 3%.  Even with a much shorter maturity of 1-3 years, which should reduce interest rate risk, the corporate bond index fund I am looking at is paying closer to 4.5%.  Corporate bonds, however, do carry default risk.  A highly diversified pool of bonds can help protect against default but a deteriorating stock market can have a negative effect on the prices of corporate bonds.  Tight credit markets can also make refinancing debt difficult, which many corporations will need to do.  Longer maturities and high-yield bonds also look attractive in this environment based on their spread over 10 year treasury yields.

Another investment theme I have developed involves energy markets and at some point possibly other commodities like metals.  I believe we are going to remain dependent on huge amounts of foreign oil for years to come.  The alternative energy programs proposed, while important, are a long way from significantly reducing our need for oil.  Since we have chosen in the near term to remain dependent on oil supplied by unstable countries that have strained relations with the United States, many different factors can lead to a supply constraint sending prices higher.  Demand has waned in the economic contraction which has kept prices low.  However, I believe the supply demand function will eventually drive energy prices higher and I will be looking to expand portfolio exposure to energy markets.  Currently I am focused on an investment with exposure to master limited partnerships and the attractive income payout they generate.  I expect to expand holdings in this area through direct exposure to price changes for raw materials and to industry groups positioned to benefit from higher demand for raw materials.

Finally, the strength of the dollar relative to other currencies will be an interesting development to watch.  There are a lot of moving parts to contend with in currency markets, making them a complicated investment decision.  For this reason I am inclined to defer most of my currency exposure to my managed futures position.  It has performed exactly as expected and is based on an index that goes back to 1985.

In summary, corporate bonds are likely to play a role in my strategies by generating income and maintain a defensive posture.  I do expect some investment opportunities in select industries may materialize.  On the international front, those countries rich in natural resources and/or exhibiting strong fiscal conditions may become attractive.  An increase in my managed futures position is also under consideration.   In general, I expect 2009 will be a difficult year for most stock investments but I do think some positive returns may be generated through investments in specific debt markets, exposure to energy and possibly other commodities, potentially select industries and foreign countries, and managed futures.

I have found using earnings and P/E's to establish entry points in broad market positions difficult.  For example, if investors wait for PE multiples to arrive at or near 15 (historical average of as reported P/E ratios), they may find the market has left them behind.  In the last bear market the as reported P/E did not hit a low until the end of 2006 at 17.4, well after markets advanced from lows hit in late 2002.

I do expect more downward pressure on U.S. stocks base on the contraction in consumer spending that is likely to stay with us until the housing and employment situations improve.  I'm not sure we will get to a level where the P/E on as reported earnings will hit 15. With huge amounts of cash sitting on sidelines looking for bargains it may be difficult for stocks to fall much further.  I would argue the risk level for starting to re-enter this market is fairly low.   We have had a healthy 50% decline from market highs.  Can it go lower?  Sure, with the risk that we become a repeat of Japan in the 90's.

Here is a look at the Historical and Estimated "As Reported Earnings" for the S&P 500

Year - Earnings - P/E

2010 - $39.59 - 19.93

2009 - $32.41 - 24.34<<

2008 - $27.69 - 28.49<<

2007 - $66.18 - 22.19<<

2006 - $81.51 - 17.40*

2005 - $69.93 - 17.85

2004 - $58.88 - 20.70

2003 - $48.74 - 22.81

2002 - $27.59 - 31.89<

2001 - $24.69 - 46.50<

2000 - $50.00 - 26.41<

1999 - $48.17 - 30.50

1998 - $37.71 - 32.60

Current and future year P/E based on a price of 789

It thought this data was interesting because, as I noted earlier, it shows that the low P/E in 2006 took place when earnings growth accelerated more quickly than stock prices.  This took place long after the market had bottomed.  I also think the 2000-2002 earnings levels are helpful when looking at current and near term projections for earnings.  When viewed from this lens the current valuation does not look nearly as bad.  Other market recoveries, however, may have taken place closer to the bottoming of the P/E ratio.

The difference in our current environment compared to the last bear market is the magnitude of our economic woes. They are systemic and global.  It is best then, to proceed with caution.

Many market commentators are hoping for a stock market rally as the Obama Administration takes the helm of our great country.  And for good reason, a roughly $850 billion dollar fiscal stimulus could be just the shot in the arm the U.S. economy needs.  Markets seem skeptical.  After traders returned from the holidays, gains made from December 24^th through January 2^nd were quickly erased.  The S&P 500 has started the year with a 5.88% decline through January 16^th.  The financial sector has led the decline ending near November lows.  Developed international markets (as defined by the MSCI ETF, EFA) are also under pressure, down 9.5% since the start of the year.

Concerns center on the need for capital at many banks.  The TED Spread has narrowed since the spring of '08, but it is still negative and credit markets are still very tight.  The recent need for a capital infusion at Bank of America and Citigroup has been echoed at other banks internationally and sheds light on the magnitude of the problem.  Some analysts expect bank failures in 2009 to exceed those in 2008.

Earnings season has provided another headwind for stocks.  Alcoa kicks earnings off with a larger than expected loss.  Ahead of Alcoa, Time Warner announced a planned $25 billion write-off in the value of its cable, publishing, and AOL assets.  Any rally attempt is likely to face a difficult earnings environment and the coming weeks will be very active.

It is entirely possible we will see a near term rally.  The last two trading days delivered positive returns on an increase in volume in the face of some very negative headlines.  On the other hand, we appear more likely visit or drop below Q4 lows in the near term based on how trading has developed since the start of the year.  If markets do rally, I am hard pressed to believe it can be sustained.  Leading economic indicators show no signs for an improvement in the U.S. economy in the next 2-3 quarters.  Using leading economic indicators from Economic Cycle Research Institute to confirm a market recovery can be a powerful combination.

I find it interesting that many of the policies that contributed to our current credit crisis are being repeated.  I realize the current circumstances are different but the need for the U.S. government to issue trillions of dollars in debt, far bigger that any amount in history is somewhat repulsive given the terrible shape our countries finances are in.  Our debt just keeps growing and our deficit remains negative.

Many of the buyers for U.S. Treasury Bonds are other foreign governments.  Can we expect them to keep buying our debt at such low interest rates, especially since some of them have announced stimulus plans that will require large portions of their reserves?  The answer is it does not matter because whatever the Treasury can't sell they will likely send over to the Federal Reserve to hold on their balance sheet (which is already ballooning).  The U.S. cannot afford to raise interest rates to make our bonds attractive to foreign buyers so much of it appears destine for the Fed.

Our debt funding at low interest rates cannot go on indefinitely and at some point is going to provide a wonderful money making opportunity.  It is possible to profit from falling bond prices and it is a reasonable position to keep an eye on. Interest rates can be held artificially low for long periods of time and until the U.S. economy starts to improve I would not expect to see much movement up in U.S. interest rates.

The energy markets are another place I am looking to make money.  I am specifically focused on income producing investments with a high correlation to crude oil.  I am also ready to act if we do get an Obama rally, and metals & mining should do well from an expected infrastructure build out.

DISCLOSURE - Some Dightman Capital separately managed account clients hold a position in an energy related ETF.  Clients also have exposure to a wide variety of equities, bonds, interest rates, commodities, and currencies through hedged mutual funds.  An inverse Treasury ETF and metals and mining ETF are on our watch list. All accounts are custodied at Fidelity.

For those of us interested in what 2009 holds for stocks the next few weeks may offer an important clue.  December failed to produce a meaningful "Santa Claus Rally".  Stocks did trend up most of the month but only closed up 0.8% above November's close.  Not a bad feat considering the first trading day of December started with a nearly 9% decline on the S&P 500.  The end of the year did see some impressive gains.  From the 24^th - 31^st the S&P 500 advanced just over 4%.  Unfortunately, most institutional investors were on vacation and trading volumes were very light.  However, we did see an improvement in stock leadership with companies like Life Partners (LPHI), Tower Group (TWGP), and Gentiva Health Services (GTIV) breaking out and companies like McDonald's (MCD), Stanley (SXE) and Mantech (MANT) approaching good entry points.  As a broad measure of stock leadership, however, the IBD 100 lagged the other broad indexes in last week's rally.

Despite a horrible retail sales season, deteriorating employment conditions, and continued weakness in residential real estate, the stock market is always looking forward and we should have a pretty good idea in the next few weeks if the market thinks the U.S. economy will be on better footing by this summer.  With lower oil prices, a large economic stimulus package in the works, lower mortgage rates and resilient U.S. workers, perhaps we will be able to look back on November 2008 as the lows of the Credit Crisis Bear Market.

On the other hand, if stocks fail to rally meaningfully in January the likelihood that the November lows will be tested and potentially broken increases.  If you are on the sidelines with cash, or in positions you would like to exit, it is a good time to pay close attention to market action.

The first trading day of December started off with the Grinch in control of stocks.  Only a day later stocks rallied and accomplished a follow-through day and as the month progressed stocks continued the rally that was launched from lows hit in late November as shown in the chart below.

It is not surprising that stocks have advanced this month; December is historically a strong month for stocks and has often been associated with "Santa Claus Rallies".  My job is to determine if this is more of a bear market rally or the start of a new bull market.  With horrible economic news arriving every day only to be compounded by the biggest Wall Street scandal ever, it is hard to believe stocks can rise in this environment.  Despite the headlines stocks are holding ground, even advancing.  It helps to remember the stock market is forward looking by many months and should start a recovery in advance of any evidence of improved economics.

The current rally has been able to avoid distribution days, described as a day when prices fall but volume increases from the previous trading day.  Unfortunately this cannot be said of foreign markets.  While many of the Asian markets are up aggressively since this rally began in late November (iShares FTSE/Xinhua China 25 Index Fund is up 47% since November 20th), the Shanghai exchange has experienced three distribution days during the period, Hong Kong exchange four.

I believe this rally will ultimately fail for the several reasons.  The start of a new bull market will involve more volume.  Stock leadership is another component that is missing for the current rally.  There have been some improvements but not enough to bank on.  In the early stages of a new bull market many leading growth stocks break out into new price territory and that is scarce in the current rally.

From a fundamental perspective, I believe stocks are going to find it difficult to continue to appreciate until credit markets improve and the financial sector has completed the deleveraging process.

Another troubling development in the current rally is the price action in U.S. Treasury Bonds.  They are soaring in price.  This is a sign investors are still very uncertain about the future for stocks along with a deflation concern.  During bull market rallies money leaves the safe haven of bonds and is invested in stocks, which does not appear to be happening in this market.  Today we see so much money going into Treasuries that real yields have been pushed into negative territory (interest rate - inflation).  10 year Treasury bonds are yielding approximately 2.63% and inflation is currently listed at 3.66%, creating a yield of -1.03%.  Take a look at the price action and pick-up in volume for the iShares 20+ Year Treasury Bond Fund.

We are not left completely void of opportunities in this market and selective entry into a few areas makes sense given the number of months and magnitude of declines in this bear market.  The drop in crude oil has presented some unique opportunities and metals/mining stocks have performed very well over the last month.  The ability for stocks to hold up in the face of some terrible economic news lately is impressive and it is possible stocks could move into a confirmed bull market from these levels.  There are also some interesting opportunities in debt market and dividend stocks worth reviewing.  For this reason I believe careful moves back into the market makes sense.