Middle East uncertainty weighing on the market

Yet another thorn in the side of the markets has developed with the
Israeli-Hezbollah War. It is probably wise for investors to have at least
somewhat of an understanding of what is happening in this war and what likely
developments could emerge as well as how surprising events could impact markets.

For those wanting more than the brief overview below, we can suggest our own PSL
and Macro Updates as well as the various intelligence services that cover the
war in detail.

Hezbollah, sponsored by Syria and Iran has become increasingly hostile and
instigated missile attacks against Israel and the kidnapped Israeli soldiers.
This led Israel to defend itself via massive air-strikes that appear likely as
preparation for a ground invasion aimed at wiping out much of the capacity of
Hezbollah. Hezbollah has launched over 1600 missiles into Israel in the last
eight days. There has been some brief ground fighting as both sides feel each
other out. Hezbollah has built a series of tunnels and caves from which they can
launch missiles and hideout from bombing raids and defend territory. Israel
probably doesn’t have the luxury of completing a proper air campaign to “clear
the road” because it will get increasing pressure to pull out. But there is
popular support in Israel for destroying Hezbollah completely, including its
13,000 missiles, hidden all over Lebanon, many of which are Iranian made. Some
see the War as an opening salvo of Iranian-US confrontation.

So far Sunni Arabs have acknowledged Hezbollah provocation of the conflict,
which is unique. Many see the Hezbollah action as an attempt by Iran to become
the dominant influence in the region and therefore more than usual would like to
see Israel issue a severe blow to Hezbollah. But there is evidence that Hamas is
also instigating increased conflicts. The War is likely to take many weeks at
least before either side is willing to seriously consider peace negotiations.

Hezbollah may well ramp up international terrorism particular against Jewish
soft targets in areas where it has operatives such as South America, Thailand,
and Africa. Developed countries will probably step up anti-terrorist security in
the weeks ahead as well. It is not inconceivable that Syria, Iran, the United
States and other countries could eventually be drawn into the conflict, though
the most likely scenario is for a quick in-and-out campaign by Israel that does
not include other countries. Hezbollah can escape to Syria or hideout in caves
and mountains and will probably not be dealt as serious a blow as Israel would
like without a prolonged ground war. Investors need to keep their eyes on this
conflict, which has the potential to disrupt global financial markets
substantially if it spins out of control and expands, or if surprising
developments ensue. So far oil prices have rallied to a minor new high and
backed off — but substantial new highs will hit an already weakening US and
global economy harder than they have to date.

This week Middle Eastern markets continued to weaken, but many markets got a
bounce off of the Bernanke rally. We suspect the Fed will have to hike again in
August and it will take a more prolonged bond market rally and evidence of a
slowdown in growth before global markets can sustain a lasting rally. If we are
wrong, breadth will expand and Top RS stocks will begin to breakout in number
and we continue watching for this to develop. It has not yet. So far what we
have in the markets is A MESS!

This difficult market environment should not come as a surprise to our readers.
In late March we began writing about the danger of the current market
environment and how in 2006 the macro big picture would likely SWAMP all trading
strategies and that not understanding the precarious position the world was in
would be a detriment to traders. We hope you listened. In addition I have
written the “2006 Investment Roadmap” and now the new “Mid-Year Update 2006
Investment Roadmap” precisely to analyze and explain why this happened, how it
was anticipated, and what it means for the future as well as what to watch to
determine how this GLOBAL TINDERBOX will blow. I still honestly believe that the
ramifications to investments of events over the period directly ahead will be as
substantial as any period in post WWII history. I honestly wouldn’t want to
trade in any timeframe without a full understanding of the current dangerous
macro environment and how the recent decline could be just the tip of the
iceberg IF certain developments transpire from here. You’ve been warned and
warned again.

Our US selection methods, our Top RS/EPS New Highs list published on
TradingMarkets.com, had readings of 9, 8, 8, 9 and 26 with 8 breakouts of 4+
week ranges, no valid trades meeting criteria, and no close calls. This week,
our bottom RS/EPS New Lows recorded readings of 92, 112, 71, 95 and 16 with 25
breakdowns of 4+ week ranges, no valid trades and no close calls. The “model”
portfolio of trades meeting criteria has some time back exited all positions and
is 100% in cash.

Sometimes the sidelines are the best place to be. We suspect we’re still in one
of those times. Conflicting forces continue to grow, and high odds sustainable
moves don’t appear likely to materialize just yet. Until they do, we suggest
mostly keeping your powder dry and watching events transpire closely.

Mark Boucher has been ranked #1 by Nelson’s World’s Best Money Managers for
his 5-year compounded annual rate of return of 26.6%.