The Week in Review:

Back to school for the Wall Street gang! Now we will see what is really in store for the stock market.

August is normally a volatile time for the stock market since many Wall Street pros are away from their trading desks for the summer. Many of the wild swings we witnessed this summer were on lower volume, which makes it difficult to judge what is really going on in the markets.

On September 18, we will find out if the Fed will cut the fed fund rate for consumers. Until then, we can expect some uncertainty. If the stock market rallies into the next fed meeting, you can bet that many Wall Street insiders already know what the fed is going to do.

Insiders Buying Financials

If insider buying is an accurate predictor, executives inside some of the nation’s largest financial firms were aggressively buying during the July and August market swoon.

According to Bloomberg,” The last time insiders bought more shares of financial companies was in October 1995, when they purchased $37.2 million" in stock.

Oddly, as bank and finance executives added to their stock holdings, investment bank insiders at Bear Stearns, Goldman Sachs, Morgan Stanley, and Merrill Lynch did not.

My analysis through year end is the telling me the market can revisit the highs for the year. A Fed rate cut will spur enough enthusiasm and confidence to drive the markets higher. October begins the best 6 months for the stock market, so investors will pile on to drive stocks higher.

2008: Is a Recession Looming?

As the stock market revisits the highs for the year, this will present investors with a good opportunity to take some profits.

While most believe lower interest rates are a good thing, our economic and finance books tell us something different. For example; why does the fed cut interest rates? The fed does not cut rates when everything in the economy is good, they cut rates when the economy is in trouble.

Oddly, one, two, or even three interest rate cuts are never enough to ward off an economic crisis. In addition, when interest rates are cut, each cut takes months to filter its way into the economy.

So, on September 18th, it will be interesting to see if the fed cuts rates as a token gesture, or will it be the beginning of several more moves to come. If more interest rate cuts are in the cards, then stock market may react negatively since it may signal that more bad news is on the horizon. If the economy is in much worse shape than previously thought, then the stock market will react harshly in the weeks and months ahead.

What will Lowering Interest Rates Do?

1) Inflation will be reignited.

Commodities rose this week as the CRB Index closed at 413.49 up from 408.65 last week and 403.72 two weeks ago.

2) Gold prices will rise.

Gold closed at $675.80, up from $671.40 last week and $667.10 two weeks ago.

3) The U.S. Dollar will decline further.

The U.S. Dollar Index, while still in a strong downtrend that began in 2002, closed at 80.79 on Friday, up from 80.61 last week.

4) Oil prices will rise.

NYMEX crude oil rose to $74.04/bbl up from $71.09 last week.

In Summary, while many believe that a cut in the fed funds rate is a good thing, we see it as a desperate measure that will eventually have negative consequences.

Play the Rally, But be ready to Sell

So, do we believe that investors should participate in the upcoming rally? By all means, yes. Do we believe that a new bull market is emerging? By all means, no.

Why???

1) Housing market is still weak, and prices have not declined enough.

a) According to the National Association of Realtors, sales of new homes increased 2.8% in July but existing home sales dropped 0.2%.

b) Inventories of unsold existing homes in July is at a 10-month supply, the largest supply of homes since the last housing recession in October 1991. Inventories are continuing to grow and as supplies expand, prices will decline to work off inventory.

c) Consumer spending ATM machines (their homes) are no longer functioning.

2) Business spending up, Consumer spending down.

a) If consumer spending accounts for 70% of GDP, and consumer ATM machines have been shut down, then business spending will eventually respond to the consumer. How can a business spend more if consumers are not providing businesses with more profits?

3) Personal income is flat to down as more US jobs are shipped overseas.

Representative Walter Jones (R-N.C.) said, "Since NAFTA was approved, the United States has lost 3.1 million manufacturing jobs."

Former Assistant Secretary of the Treasury in the Reagan Administration, Paul Craig Roberts wrote; “According to the Bureau of Labor Statistics, one-quarter of all new US jobs created between June 2006 and June 2007 were for waitresses and bartenders. Almost all of the net new US jobs in the 21st century have been in domestic services."

Given this tidbit of news is there any wonder why the University of Michigan’s consumer sentiment data shows a slow steady decline in sentiment?

In our opinion the chances of a recession in 2008 are favorable. Merrill Lynch economist David Rosenberg puts the odds of recession at 65%. A few months ago it was 25%.

Taking all of the above into consideration, I believe a Q4 rally is worth participating in, but also believe investors should stand ready to take chips off the table as the rally unfolds.

We raised our allocation to the stock market by another 5% when the Dow dropped below the 13,000- 12,800 mark and the SPX to below 1400. Our asset allocation now stands as follows;

70% Equities: (Normally 95%) Aggressive
60% Equities: (Normally 80%) Moderately Aggressive
50% Equities: (Normally 60%) Moderate
30% Equities: (Normally 40%) Moderately Conservative
15% Equities: (Normally 20%) Conservative