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.

After a roller coaster ride this summer investors want to know what the fall is likely to bring for the stock market.  No one knows for sure but the following technical and fundamental data provides some clues.

From a technical perspective a great deal of damage was done to stocks in the most recent selloff.  One of the longer-term indicators I use is an oscillator that measure the distance between 13 & 34 week moving average of an investment's price.  This particular indicator has been very good at identifying risky periods to own stocks. 

As you can see in the chart below, back in early 2008 an early warning signal was generated by this indicator (lower portion of the chart).  Once the indicator moves below zero, which means the 13 week average has fallen below the 34 week average, it might be identifying a long-term change in the direction of stocks.  This indicator worked well in 2000 and 2008 and may in 2011 as it recently turned negative. (Click chart for full view)

Another indicator that can be helpful in determining the health of the overall market involves looking at the number of stocks trading above their 200 day moving average - the higher the percentage, the healthier the market.  (Click chart for full view.)

As stocks moved into 2008, more stocks slipped below their 200 day moving average signaling a change in market character.  The trigger point is 45% for a bearish environment (red dotted line), 55% for a bullish environment and neutral between the two.  The indicator slipped below 45% during this summer's sell-off.

Stocks have demonstrated some strength recently.  Another helpful analysis would involve looking at what sectors of the economy led the most recent rally.  Going back to early August, when the current rally began, the top performing sectors has been defensive in nature: Utilities & Healthcare.  Technology, financial and industrials have underperformed.  This would indicate that those who are buying stocks in the current environment are doing so with some caution.  (Click chart for full view.)

Turning our attention to fundamental data, the strength in corporate earnings during the economic recovery has been spectacular.  Since corporate profits are a reflection of the economy it may be helpful to look at both the sales and earnings of companies in the S&P 500.

Standard & Poor's has listed the last several quarters of "Revenue" as follows:

2010 Q1 $221.80/share

2010 Q2 $236.5

2010Q3 $240.84

2010Q4 $252.73

2011Q1 $250.89 (decline from previous quarter)

As the chart below illustrates, even with a decline in profits during the first quarter of 2011 profits rose.  This could have only been achieved by reduction in expenses or financial engineering. 

The chart also illustrates that during most of the last decade revenue has grown at a fairly constant rate other than the last two recessions.  On the other hand, "As Reported" earnings have experienced big swings during the last 10 years and the most recent surge is due to extensive cost cutting in labor, inventory, benefit reductions and delayed or cancelled expansion projects.  Profitability from managing expenses is not sustainable.  Q2 revenue is on track to show a significant increase (final numbers have not been calculated) but companies may find it difficult to keep growing earnings if consumer confidence delivers weaker revenue in future quarters.  McDonalds released a dissappointing global sales report on Friday.  Investors would be wise to stay alert to additional weak sales reports or forward guideance revisions.  (Click chart for full view.)

Investors should also consider the fairly consistent relationship between annual changes in gross domestic product (GDP) and earnings for the S&P 500.  With a widely accepted belief we are in the early stages of a slower growth environment we can expect earnings to follow a similar path.

It is also helpful to acknowledge that GDP has historically averaged approximately 6.5%.  With expectations for GDP well below the historical level it may become very difficult for corporations to continue to grow revenues.

The technical data is telling investors to steer clear of U.S. related stock investments for the time being.  There may be some international investments and specific asset classes that may have more fully discounted a global economic slowdown and offer safer entry points. However, the global economy still relies heavily on the U.S. for growth and further weakness here is likely to impact global stocks.

The fundamental data is a little fuzzier.  Corporations have been able to grow revenues.  If the trend continues earnings growth may depend less on cost cutting and businesses may be more willing to hire and expand.  Some long leading indicators suggest the current slowdown should reverse by the end of the 4^th quarter and that may keep U.S. stocks from falling much further.

The biggest overhang at present is the sovereign debt issues faced by many countries around the globe but concentrated in Europe.  It is a problem that is likely to challenge investors for the next decade or two and is only complicated by aging populations.  It is for these reasons we believe an emphasis on risk management during this period will prove valuable to investors.

Investors should now be focused on building watch lists for potential purchase when markets stabilize.  Since global stocks started their decline at the end of March, in additionl to defensive sectors, Biotech has held up very well.  On the other hand, copper has sold-off hard.  Keeping an eye on both strength and weakness in the markets can help investors use both momentum and valuation strategies to make purchase decisions.  I would suggest we are not at that point but some asset classes might represent a reasonable entry for an initial position.  (Click chart for full view)

Technical analysis can be helpful to an investor.  I use a variety of technical tools in my assessment of markets but recognize their limitations and how to deal with them.

There are a few technical indicators that I place more emphasis on than others.  One indicator involves comparing two different weekly moving averages.   When it turns negative, a signal is generated which often marks the start of a sustained downward move.  Negative readings recently took place in Broad US and International Stock indexes.  Applying this indicator to the 9 Select Sector SPDR Funds we learn:

• Consumer Staples & Utilities remains in positive territory
• Healthcare, Energy, & Consumer Discretionary are on the cusp of turning negative
• Materials, Financial, Industrials, & Technology are firmly in negative territory

In 2008, all 9 Select Sector Funds fell deep into negative readings.  At present, some of the Sector Funds appear to be in better shape compared to how they looked leading up to the late 2008 and early 2009 declines.

Leading stocks, however, are not demonstrating the strength normally associated with market rallies.  Remember, we are over 2 years into this stock market rally which can prove to be a challenging time and prone to failure.  Value indexes were some of the top performers on the follow-through day, another potential warning sign.  Finally, volume has been much higher on market declines and suspiciously low on advances.  In ideal market conditions the opposite is usually observed.

The jury is out regarding the likely direction for stocks.  A move above 1,200 or below 1,100 for the S&P 500 would represent an important development.

Since coming under accelerated selling pressure on August 4^th, stocks are attempting to stage a recovery that so far has been unconvincing.  The tell-tale sign comes in the form of volume.  As a market observer, I am interested in knowing what investors are actually doing, not just saying.  There is a lot of talk about “stocks being on sale” given the most recent sell-off.  That type of statement relies on rosy earnings forecast and based on adjusted as reported earnings reports I follow, I believe stocks are nearly-fair valued.

At this point in the market recovery I would suggest the likelihood stocks are going to stall or fall further is higher than a sustained rally.  The chart below gives as a very clear indication there are more sellers than buyers.  Generally for a market rally to bust out into a strong sustained upward move we would see more buyers come in on rallies.  So far, the volume on market advances (black bars) has been well below the volume on declines (red bars), telling us there are still more sellers than buyers.

I am not convinced the slowdown is going to turn into a recession but in this fragile state the risk we could is elevated.  On the other side of the ledger, I am viewing this market as more of a trading environment; if convincing upside action develops I am prepared to move back into the market.  There are a few investments that are starting to look interesting.

It has been a busy week at Dightman Capital.  I further reduced risk levels across my global growth strategies just before Thursday's massive decline.  With Friday's S&P announcement a new element of uncertainty has entered into the market.  Some commentators are suggesting stocks have already price in this development with the nearly 11% decline on the S&P 500 since July 22^nd.  Others expect a sell-off Monday morning and recovery by the close.  The real action may be in the bond market.  CPI has been ticking up and with a reduction in credit quality, we may start to see bond investors' demand higher interest rates, especially further out on the curve.  It is also possible Treasuries will see little action.  Comparatively speaking, they still represent a better alternative in many respects.

Regardless of what happens Monday or next week for that matter, I believe the following developments have surfaced that investors should address.

• Economic growth is slowing in the U.S. and in other regions around the world
• CPI is trending higher in the U.S.

There are several reasons why I believe economic growth is slowing but I am not going to rehash all of the reasons here.  Instead, I am going to discuss P/E Ratios, GDP and price stability.  They are all interlinked and the key to understanding the factors influencing the stock market's direction.

I believe we are in a secular bear market that may have just completed its second cyclical bull market.  If you are interested in learning more about market cycles, visit Crestmont Research. Ed Easterling has published an enormous amount of free research on the subject.  He has also published Unexpected Returns and Probable Outcomes, two books I highly recommend.

Ed does a wonderful job explaining how Nominal GDP (Real GDP + Inflation) leads to sales, which leads to earnings in his book, Unexpected Returns.  Inflation or deflation is what we need to pay attention to in the current environment.

There is no question parts of the economy are experiencing an unstable price environment.  Residential real estate continues to experience deflation while energy, food, college tuition and other costs are on the rise.  With CPI trending higher we may be entering a period where price instability will likely lead to a decline in the stock market.  Ed explains price changes as the "Y" effect, where high inflation or deflation leads to a low P/E ratio and stable inflation leads to a high P/E ratio.  We are in a period where we should expect the S&P 500 P/E ratio to decline from near fair value, if we move from stable to unstable prices.  The P/E ratio decline can be extreme and over a short period or moderate and over a longer period.  It is impossible to know the timing, but I believe the likelihood of price instability leading to a lower P/E Ratio is high and investors would be wise to engage in more actively managed strategies like those at Dightman Capital.

Interest rates are another area to watch closely.  While monetary authorities have more control over short-term rates, intermediate and long-term rates are dictated by expected monetary inflation and default risks.  As a financial planning note, individuals with variable rate debt obligations may want to lock down a fixed rate, if possible.

While the current environment has increased some risks for investors, it may also present opportunities.  The Global Growth strategies managed at Dightman Capital are able to invest in a wide variety of investments and include alternative strategies.  Now is the time if you want to make a change.  If it takes another decade to emerge from the current secular bear market, you may find yourself very disappointed with the status quo.

Stocks confirmed an uptrend on Tuesday's strong rally.  We have seen other rallies fizzle recently so it may be short lived but the market appears to be showing signs of wanting to move higher.  As earnings season shifts into gear many reports are beating estimates with generally more positive than negative forward guidance.  In terms of ongoing global debt problems, Europe continues to search for a solution to their crisis as U.S. policy makers try to agree on how to raise the debt ceiling.

These are not normal times.  While a negative outcome to some of today's debt issues remains small, the impact should one materialize could severely impact asset prices.  That is why I believe today's environment requires a more active investment approach.  There is much debate about active versus passive investment strategies.

I am not firmly rooted in one investment camp (passive versus active) or strategy (core/satellite, tactical, sector rotation, etc.).  I believe different strategies are going to be favored in different environments so I pay close attention to the prevailing environment to determine if it is a bull or bear market and deploy our strategies accordingly.  I look forward to the day when a more passive approach can be implemented in our strategies.

In a study by Doug Short comparing monthly moving average strategies (active) versus buy-and-hold (passive), one of his conclusions is that buy-and-hold is a successful strategy on the way up but a losing proposition on the way down.  There is the risk for investors.  Sustained market declines can devastate an investor's wealth, especially investors that are living off of investments during retirement.  That is why I believe a more flexible approach to investment strategies is likely to produce better results during the type of conditions we presently face.

In terms of Macro Economic Policy, I encourage readers to view the latest issue of Outside The Box, by John Mauldin.  It is free and you can sigh-up here.  This issue is authored by Lacy Hunt and it provides an updated view of economic policy in light the more robust stream of data available to policy makers today.

Lacy believes we're likely to see more deflation as the world contracts from the massive debt balance built up over the last couple of decades.  If he is right, there should be opportunities to purchase assets attractive price levels in the future.

Monday's big stock selloff has renewed pressure on the stock indices.  Ongoing debt concerns in Europe sparked the recent selloff.  Leading stocks are also starting to show lackluster trade.  Informatica (INFA), Deckers Outdoor (DECK), Jazz Pharmaceuticals (JAZZ) and Carbo Ceramics (CRR) all completed base patterns on uninspired trade last week and fell back in their patterns this week.  Most leading stock breakouts haven't made much progress lately.

Earning season kicked off with Alcoa (AA) turning in mixed results.  Chief Executive Klaus Kleinfeld expects demand for aluminum to grow my 12% this year.

We can expect the roller coaster ride to continue for the foreseeable future.  Leading economic indicators are pointing to a global slowdown but some indicators remain on solid footing as illustrated in the chart below from Fidelity. 

For a reminder why I am approaching the current environment with caution take a look at this brief set of charts by Doug Short.  It is a good reminder of just how much damage a secular bear market can cause and how long they can last.

China is busy engineering what so far has been a soft landing; reaffirmed with growth data released this morning.

At present, commodity related investments appear to be showing the most strength, just what you would expect when The Fed is ready to throw more money at our wobbly economy.

U.S. stocks have been struggling for nearly two months now.  Early in the correction I made some defensive moves, not because U.S. stocks indexes started to see big declines, but because those declines were accompanied by warnings about a global economic slowdown later this summer by leading economic indicators.  There are other aspects of managing investments in a secular bear market that influenced the decision as well. 

When selling comes into the market it helps to dissect the action for possible clues about the future direction.  As I have noted in other posts during this time, leading stocks with strong fundamentals have held up well in the current sell-off.  This is a more bullish data point.  The IBD 50 only declined 0.8% in Friday's sell-off, versus a fall of 1.3% and 1.2% for the Nasdaq and S&P 500 respectively.  We have even seen broad strength in some of the attempted rallies.  So the market appears conflicted and that is one of the reasons I have only become partially defensive and stand ready to put money back to work.

It is natural for the market to take a breather and consolidate gains.  In this environment, however, it would not take much for a consolidation to turn into a severe market decline.  With ongoing debt issues in Europe, unrest in the middle east, the tragedy in Japan, high unemployment, local-state-federal debt issues, ongoing housing weakness, the potential for a new crisis to erupt is higher than normal and could send stocks into a tail spin.  That is why risk management is playing a more important role in our strategies than growth or tax efficiency.  There will come a time where we can rearrange the priorities in our strategies, but we are not there yet.

Beyond our initial defensive moves much earlier in this sell-off, current stock market and business cycle data has not suggested any additional action.  As a matter of fact, in some asset classes attractive entry points may be forming.  I am always on the lookout for good investment opportunities.  India's stock market started its correction back in November and has piled up much bigger declines.  Late last week it started a rally attempt.  If the current rally attempt sees a follow-through, it may prove to be an attractive entry point.

In terms of the broad asset classes I track for a general sense of market opportunities, International Fixed Income had the strongest price performance over the last 4 weeks, followed by U.S. bonds.  The U.S. Dollar and Emerging Markets had the strongest gains for the week. 

The defensive team has clearly take the field for now but I stand ready to put money to work in more aggressive assets should my analysis suggest it is a good time to do so.