Index Advisor 017
2/28/2007 8:19:31 AM

Recommended Trades:

There are no trade recommendations at this time.

Open Positions:

In general, once we have entered a position, we will issue an alert to exit the position. We will note likely target areas for a trade, but we buy and sell on signals, rather than target areas. The same method applies to stops, as we don't use classical stops, but rather rely on the signals generated to reverse or exit our positions.

Overview:

There was a lot of discussion of a plunge in the Dow of some 200 points at around 3:00pm EST. A "computer glitch" caused the computation of the Dow to fall behind as stocks moved lower and "the tape" plunged downward in less than a minute to where the Dow was down 550 points at one time. All the major indexes are now trading below both the 20-day and 50-day moving averages.

Well before the open, the Shanghai market closed down 8.8%, the largest one day decline in ten years. This infected all other equity markets as all that we track closed down. It was a record day by a number of measures, but as a percentage move, wasn't as extreme as seen in the past.

An hour before the open, durable goods orders were reported at a -7.8% annual rate for January, with a -3.1% with transportation excluded. Expectations were for a -3.0% headline number and a +0.2% ex-transportation. Probably the most important is that business spending is down 6%, which is quite bearish. Housing starts were above expectations at an annualized 6.4M versus and expected 6.24M. Finally, Michigan Consumer sentiment was reported at 112.5 versus an expected 109, which in itself is quite bullish.

Oil rose seven cents to close at $61.46. Natural gas fell a penny to close at $7.533.

Market internals were the most negative we have seen in years. The decliner over advancer ratio was an astounding 12:1 on the NYSE but only about 8:1 on the NASDAQ. We are surprised to see anything over 4:1, which is a significantly negative day. The Index Put/Call ratio rose to 2.84. The rise on Friday was attributed to expiring options and re-buying to maintain the same level of put exposure. Today's buying was fearful.

It took a single day to wipe out market gains since last fall. The system we use always positions for the probabilities, and in this case, that is what occurred. Tuesday's move was a statistical anomaly, with such a large move in a single day. However, as we have been repeating, the market has been discounting geopolitical risk, negative economic reports, warnings from the Fed, etc.

Prior to the market opening, we not only had the Shanghai stock exchange debacle. We had an attempt on VP Dick Cheney's life in Afghanistan, as well as Freddie Mac raising lending standards for loans they will purchase. Talk about closing the barn door after the cows have left!

After all the turmoil of corruption and ineptitude of leaders at Freddie Mac and Fannie Mae, as political appointees responsible for these huge quasi government housing load underwriters, Freddie Mac is now concerned about sub prime loans. You can just bet that taxpayers will be paying for more mistakes here, just as with the Savings and Loan bailout of the 80s. That will cause Congress to raise taxes and further slow the economy.

This has been in the makings for awhile. Housing will eventually cause the Fed to ease rates, currently predicted for the second half of this year. The collapse of sub prime lenders and its ramification to Freddie Mac and Fannie Mae could be enough to drop the economy into recession. Retired Fed chief, Alan Greenspan suggested that the economy could enter a recession by the end of 2007. Of course, he is on the talk circuit now, rather than leading the Fed and it is Ben Bernanke's banner to carry now, but Greenspan's comments will be considered seriously.

Conclusion:

All of the bearish birds are coming home to nest. How long will the market continue on a downward path? We don't know. The market may very well bounce immediately here, but will that bounce hold and what character will it have? Only watching the market will fill in those blanks.

There are still plenty of bulls who will be buying the dips. The question is about bearish sentiment entering the market. With all of the negatives and the slowing economy, will investors finally adopt a more cautious stance? Again, we don't know, but it has been somewhat overdue. The length of the run up without a 2% correction on both the Dow and the S&P-500 hasn't been seen in nearly 50 years. The odds were strong that it wouldn't last. Now, it hasn't. That doesn't mean, however, that downside action continues here, especially not without something of a bounce.

Stay tuned for more.

Regards and Good Trading,