(January 27, 2008)

Dear Subscribers,

I realize that the events over the last few weeks have been very difficult and frustrating for many of our subscribers. This has been by far the most difficult market for retail investors since we started writing regularly in August 2004. In a way, this has been a test for us as well. So far, I would argue that we have passed our test admirably, as our 7 most recent signals in our DJIA Timing System can attest to:

1st signal entered: 50% long position on September 7, 2006 at 11,385;

2nd signal entered: Additional 50% long position on September 25, 2006 at 11,505;

3rd signal entered: 100% long position SOLD on May 8, 2007 at 13,299, giving us gains of 1,914 and 1,794 points, respectively.

4th signal entered: 50% short position on October 4, 2007 at 13,956;

5th signal entered: 50% short position COVERED on January 9, 2008 at 12,630, giving us a gain of 1,326 points.

6th signal entered: 50% long position on January 9, 2008 at 12,630, giving us a loss of 422.83 points as of Friday at the close.

7th signal entered: Additional 50% long position on January 22, 2008 at 11,715, giving us a gain of 492.17 points as of Friday at the close.

While our two latest signals are just barely in the green, we are glad that we were able to go 50% short in early October at a DJIA print of 13,956 - and to close out that position in early January for a gain of 1,326 points. For those who like to avoid shorting/hedging as an investment or trading strategy, you would have also avoided the general volatility and gut-wrenching feelings that most investors experienced over the last few months if you had stayed in cash. More importantly - having avoided the dramatic decline over the last few months - this would've put you in a great psychological position/advantage in going long early last week. Even had the stock market declined another 10%, you would have still been better off than most investors. Unless you believe the U.S. is entering a severe recession (I have discussed why this is a low probability event in our last few commentaries), chances are your portfolio would outperform bonds/treasury bills by a significant margin over the next several years.

To recap: The purpose of MarketThoughts.com had always been to empower investors - to "democratize" finance and to help our readers maximize gains during a bull market and to protect assets during unfavorable market climates. We do not profess to be innovators when it comes to doing market or economic research. Rather, we read and aggregate a huge/diverse amount of original research and subsequently come up with our own views on where the financial markets and certain asset classes are heading. We also help provide insights into the factors that will affect the stock market and individual stocks - focusing on both fundamentals and technicals of the current stock/financial markets, as well as more general investing topics such as the Dow Theory, investing psychology, and financial history. So far, I believe we have satisfied these goals.

I believe it is at times like these where you would have to trust us. Sure, I believe I have already provided enough evidence suggesting that the U.S. stock market (in particular consumer discretionary and financials shares) had already discounted a mild U.S. recession at the beginning of last week. Moreover, I do not believe a U.S. recession, even a mild one, is inevitable at this point. I also do not believe for one second that you should place your financial trust into the analysts or newsletter writers who: 1) missed the top in either mid July or early October, stayed long through the first week of January, and are only urging investors to get out now, or 2) were too early, warning of an inevitable peak in the markets as early as 2006, and have only been "vindicated" over the last few months. This also applies to economic forecasters - the economists who have been optimistic all along and who have just been recently revising their economic forecasts are simply too late, and should be ignored. In terms of economic forecasts, subscribers should only pay attention to four leading outfits/indicators: 1) The ECRI Weekly Leading Index ("WLI"). The ECRI has been one of the most accurate economic forecasters over the last 20 years. Moreover, as the name of their indicator implies, the beauty of their U.S. economic leading indicator is that it is updated on a weekly basis, 2) The Conference Board's monthly leading indicators, 3) The OECD leading indicators - this is slightly delayed but aside from a U.S. economic leading indicator, the OECD also provides leading indicator readings (using a consistent methodology) for over 30 major economies around the world, and 4) The UCLA Anderson Forecast, which is released on a quarterly basis, but is again, one of the most accurate economic forecasters over the last 20 years. In particular, the ECRI Weekly Leading Index (of which I am a subscriber) had been weakening since late August 2007. In late November, it started to dive dramatically - implying a dramatically weakening U.S. economy 6 to 12 months out, or sometime in late May 2008 and onwards. Amazingly, no one (and certainly not the mainstream media) paid heed to their advice until it was too late.

At this time, none of these four leading services/indicators are predicting a U.S. economic recession just yet. In particular, the ECRI, in their "special supplement" last Friday, stated that there was still a window of opportunity for policy makers to fend off a recession, as long as any stimulus (either from the Fed or Congress) is done quickly and efficiently. Moreover, one of the most crucial factors that have typically led a classic U.S. recession - high inventory levels - is conspicuously missing from the current cycle. More importantly, not only had the U.S. inventory-to-sales ratio failed to rise over the last few months (which was the case immediately prior to the March 2001 to September 2001 recession), but had actually declined to a new low as of the end of November 2007:

The "inventory cycle" has historically driven the U.S. into past recessions. That is, manufacturers have historically tended to be too optimistic even as demand starts to slow down - subsequently prompting a severe cutback in production and layoffs to work off excess inventories. This was also the case immediately prior to the March to September 2001 recession, as inventories had started to mount since the beginning of 2000. In the current cycle, however, this had not been the case. In fact - owning to surprising economic strength in the third quarter of last year, as well as continuing pessimism among manufacturers and retailers alike during the second half of 2007 - inventory levels (as indicated by the inventory-to-sales ratio) actually declined to a record low as of the end of November 2007. Combined with a very weak U.S. dollar this time around (by comparison, the U.S. dollar had been very strong going into the March to September 2001 recession), there is a very strong chance that the U.S. could avoid a recession by using any excess production to "export its way out" of a recession.

So what now? As I discussed in our mid-week commentary, financial assets (especially consumer discretionary and financial shares) are now pricing in a mild U.S. recession. Also, I believe the Fed will ease by 50 basis points on Wednesday. As discussed in our mid-week commentary, the markets is still "screaming" for a 50 basis point ease. Not only is the Fed Funds futures market projecting for a 50 basis point ease, but the still-elevated levels of the "TED Spread" (the difference between three-month LIBOR and three-month Treasury yields) still suggests for such a significant easing, as shown in the below chart:

Despite the 75 basis point easing by the Fed early last Tuesday, the 5-day moving average of the TED spread still remains at an elevated level of 1.13% (actually up from 0.96% from the Friday prior to the easing). Given that the TED usually trades below the 100 basis point level (and more often below the 50 basis point level) during "normal market conditions," there is no doubt that the Fed would ease by 50 basis points this Wednesday (keep in mind that the next schedule meeting after January 30th isn't until March 18th) - which should, hopefully, bring an end to the current panic in the global financial markets.

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