2011Aug8 Portfolio Update

Wednesday’s market closed with a very small rally which limited the consecutive down days in a row to seven. 1978 was the last record of eight consecutive market down days. However, the rally has not continued.

With the Debt Limit Legislation completed, analysts had been looking for a Resolution Recovery in stocks rather than the Resolution Rout that is with us. The search for explanation has begun since stocks were considered by many to be oversold as recently as Tuesday.

The number of stocks in the S&P-500 above the 50-day moving average has declined since late last year to 14%. At that level, traders expect a good rally, not a collapse. It is a matter of perspective. Robert Shiller, Ph.D. of Yale adjusts corporate earnings and warns of an additional 30% decline potential! Then, we would be back to normal.

Relative strength is a trend following decision process instead of a bet on the future. Our Dynamic Asset Evaluation process tripped two switches on Tuesday. Commodities moved from #2 to #1 and Domestic Equities did the reverse. Secondly, equities joined commodities in failing to beat cash, the alternative to being invested.

Those changes resulted in decisions to sell all exchange traded funds in our IR Select and IR Global Opportunity Portfolios. IR Relative Strength 401k Portfolios were, also, moved to cash.

The only long-term trend remaining positive is for Domestic Equities, and it is weakening. The other asset classes have cautionary long-term trends requiring very selective holdings on a tight leash if already in a portfolio.

Increasing the federal debt ceiling means more spending, not less. The budget reductions amount to a rounding error in our federal budget. They are not enough to impact our national debt level. Increased taxes from health care legislation and the expiration of current tax rates beginning in 2013 were not considered tax increases in the debate. The debt ceiling was not a threat to our country’s credit rating; excess spending was and still is.

We are not so far removed from the financial mess in Europe. Just replace Greece with California when discussing budget problems. You need not go far to find others; Nevada, anyone? Michigan?

The cost of borrowing has become so high for Spain and Italy that they quit selling bonds to pay for their deficit spending. The European Central Bank decided to buy the bonds. How long can that last? European banks are selling gold to raise cash. It is possible for financial contagion to move from Europe to U.S. banks.

All levels of government are staring at personnel reductions which will negatively impact both consumer sentiment and spending. Government employees are increasingly joining the unemployed.

We are early still in the contraction of consumer spending. Next year, the consumer spending contraction escalates due to demographic changes.

More private sector jobs will help but cannot fill the spending void created by Boomers facing retirement. Adding government austerity and higher taxes to reduced consumption is not a recipe for growth.

Is there any good news for investors? Yes, the current selling will abate. The spill-over effect on foreign markets will open some great opportunities. If interest rates spike here as they have in Europe, we will become buyers of high quality bonds.

Growth estimates for the last half of the year have become more conservative. It is still growth which can create a market rally able to last for several months. Prices will identify a change in investors’ outlook for the economy and markets. Then, we can change portfolios from defense to offense.

“There is barely a bond anywhere in the world I would buy right now. Bonds are heinously expensive here. Everywhere I look, equities beat bonds hands down,” said Pat Dorsey, vice chairman of Sanibel Captiva Trust.