Not a clear environment yet

Fed action or non next week may dictate a few days of high volume activity and
bears watching not just in terms of market reaction but in terms of what the Fed
is saying and paying attention to. Futures markets are discounting a less than
40% chance of a rate hike in August. We suspect the odds are tilted a bit more
in favor of a hike than even, though not substantially — and what the Fed does
and says this next week may become quite important in setting a new environment.
There IS evidence of a slowdown materializing in the US growth rate. Housing in
particular is weak, as are auto sales. Consumption is showing BEGINNING signs of
weakening. Yet the ISM manufacturing index is still above levels normally
associated with a pause in Fed tightening. And most significantly, inflation
gauges are still pointing to higher inflation, even while growth slows. The past
quarter was actually minor stagflation. We suspect that lower growth while
lagging inflation gauges (and lagging rent measures) continue to rise may obtain
for another month to quarter.

Bernanke is considered an expert in the so-called “sacrifice ratio,” which
roughly measures the amount of employment growth you give up at a given time by
tightening more in order to prevent an inflation problem from getting out of
control in the future. The sacrifice ratio is currently quite high, meaning it
would be judicious to err on the side of being too tight. Bernanke cannot afford
to let the inflation genie out of the bottle, and as inflation gauges climb, we
suspect he will be pressured to either raise rates or consider doing so heavily
enough that a “tightening is over” full-scale rally will not be at hand yet. The
key will be in his comments this coming week. If the Fed pauses but still notes
that higher inflation gauges could lead to further tightening, or if the Fed
tightens but does not make it absolutely clear that this is the last hike,
market reaction could be muted on the upside. On the other hand a pause with
comments of confidence that hikes are behind us, could lead to a non-explosive
further leg up to at least test the highs of earlier this year. A STRONG close
by
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the markets are starting to look beyond current inflation numbers.

Regardless of the Fed’s move and comments, we should let market action be the
guide. Strong rallies in the major averages accompanied by high volume to create
a follow-through day would be the first sign of more upside ahead. The real
excitement may not come until the breadth of Top RS new highs starts to expand
broadly and stocks meeting our runaway up fuel criteria begin to break out with
some plurality. Until then, we still suggest keeping your powder mostly dry.

We still like Large-Cap-Value over small caps and
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some of our favorite plays. Yet we still regard this as a TREACHEROUS
ENVIRONMENT where CAPITAL PRESERVATION SHOULD BE PARAMOUNT. Don’t allocate
heavily to anything that doesn’t scream at you.

The Israeli-Hezbollah War has FINALLY evolved into a ground war as we
anticipated in our prior comments. Now it’s a race. The Israeli’s must try to do
as much damage as possible to Hezbollah before they are forced into some sort of
peace initiative that compromises their goal of doing lasting and material
damage to this terrorist organization that is armed with more weapons than
Lebanon itself and continues to be able to send Iranian missiles into Israel at
will. For Hezbollah they will try to hideout in their prepared bunkers and
necessitate as many casualties as possible on Israel while hiding their missiles
and trying to maintain their ability to fire them at any time. Some global
leaders have expressed a deep concern that world opinion does not understand the
potential of what is at stake in this war. If Israel cannot do lasting and
material damage to Hezbollah, who innovated suicide bombing, it will teach Iran
and the radical Islamic world that terrorism is THE way to achieve its
objectives, and global terrorism will soar. Iran may even suspect that the west
is so spineless that they will not stop it from acquiring nuclear weapons — and
the potential is for the Islamic terrorist war to become MUCH more widespread
down the road than if a lesson is taught now. Appeasement to terrorists may
simply create a much more widespread conflict down the road. This fight MAY be
much more important than most realize in shaping the environment of the next
decade. Whether this opinion is true or not, it is at least probable that the
War has and will continue to effect markets and add uncertainty and risk to any
potentially bullish outlook.

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.

Our US selection methods, our Top RS/EPS New Highs list published on
TradingMarkets.com, had readings of 26, 26, 31, 18 and 34 with 18 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 34, 23, 13, 32 and 21 with 10
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.

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%.