Adviser's Blog

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Part I: Introduction
Historically, a significant increase in market volatility accompanies a market inflection point. Using history as our guide, it certainly feels like we are at inflection point. While we are entering a seasonally strong period for equities, the winter months do not guarantee positive gains. In fact, the two bear markets that I’ve consistently compared the next bear market to, 1937 and 1973, both started during this seasonally strong period for equities. The ‘37 Bear started in early March while the ’73 Bear started in January.

In the Market Outlook portion of this update, I’m going to briefly cover two very disturbing developments in the capital markets that merit our full attention. But first, I need to get the administrative part of my update out of the way, so here is my account performance on a YTD basis. Read the rest of this entry »

Several significant events happened today which I think are worth noting.

Oil Prices Hit New Record High
Oil hit a new high of $98.62 before closing at $96.70. USO, the Crude Oil ETF, is up over 45% for the year.

While this development is bothersome, it was to be expected as there has been an unprecedented draw in inventories over the last 13 months. Since the beginning of October ’06, energy inventories are down 7.5%.

In June, I made my first post suggesting that oil prices would continue to climb in light of the draws in inventory. Since then, the rate of inventory draws has accelerated. Initially, the climb in oil prices was a subtle confirmation for me but now it just flat out scares me. I’m very concerned about oil prices and where they might go.

It is currently estimated that the world is consuming around 88M barrels a day and only producing 85M. Production is going to continue to decline as the 40 year-old “elephant fields” lose production capacity. There hasn’t been a major oil discovery in over 4 decades and even if there is one tomorrow, it will take years for it to begin producing. If there are any supply disruptions in the form of weather or geo-political instability, the ensuing rise in energy prices could be detrimental to the entire global economy.

With that said, prices should pull back at some point. But that was my sentiment in October and I was wrong then so I could be wrong again. Prices may continue to climb until prices choke off demand.

The US$ down over 10% YTD!
As of today, the US$ trade-weighted index is down over 10% YTD. This means that most of the stuff we buy from overseas is now 10% more expensive than it was 10 months ago and everything we make here is 10% cheaper to foreigners. Wall Street will tell you that this is good for “multinationals” like MMM, CAT, BUD, ect. The government will tell you that this development will benefit our trade deficit. There is much debate whether either of these are true. What I do know is true, is that these trends have resulted in hardships for my 89 and 92 year-old grandmothers who are struggling to pay their utility bills and nursing home dues.

A falling US$ will lead to more inflation, higher interest rates and quite possibly a significant sell-off in US equities.

Gold reaches new cyclical high
Given the prior two trends, it’s certainly not shocking that Gold closed at another cyclical high today, not far from its all time high of 870 – a level which should get taken out soon, but possibly after a pullback. The two primary Gold ETFs, GLD and IAU, are up 30% YTD.

While Gold is near its all-time highs when priced in US$’s, it is still very cheap when priced in oil and other commodities and still well below its cyclical highs when priced in Euros and other established foreign currencies.

GM Takes $39B Write-down
Of all of today’s developments, the GM story is the most intriguing to me. Today, they announced a $39B write-down. According to an article by the Associated Press, the primary driver behind this write-down is “a $38.6B non-cash charge related to accumulated deferred tax credits in the U.S., Canada and Germany.”

But the article went on to say:

But the markets aren’t buying it, sending GM stock into a mild decline. That’s because there’s plenty of other bad news. Just a few years ago, General Motors Acceptance Corp., the financing arm that’s 49 percent owned by GM, was the company’s life preserver, with robust profits from loans relating to the housing boom. Now it’s an albatross, contributing a $757 million loss in the third quarter–virtually all of it attributable to mortgage write-offs.

On CBSmarketwatch, the following was said…

GM said that confidence has been shaken by sluggish earnings growth in its core North American automotive market and setbacks at GMAC Financial Services, its lending business.

GM said there was a “significant” decline in net income at GMAC and increased corporate expenses. GMAC, of which General Motors holds 49%, lost $1.6 billion. It was caught up in the subprime turmoil that has rocked mortgage and credit markets.

What makes this intriguing for me is not that GM’s stock got hammered today because of this news. I am neither long nor short GM (Although I do drive a GMC Envoy). It’s intriguing because it is representative of how much our nation’s earnings are tied to the financial space. While “financial” stocks only make up 22% of the S&P 500’s capitalization, there are a lot of non-financial companies that derive a substantial part of their income from “financial activities”. Therefore, earnings from “financial activities” accounts for even more earnings in the S&P than earnings from “financial stocks” alone.

And why is this important? I have long argued that the earnings in the financial space are a sham, which it is finally becoming apparent that I was correct. (It didn’t take a genius to figure this out, banks have always “cooked their books” and when they issued blow-out earnings in Q1 despite the troubles in housing, it was pretty evident that something was amiss.) Since earnings in this space were questionable at best, I have also argued that we should discard their earnings when trying to value the S&P 500. As of Q2, the average P/E for the S&P, including the financials, was in the neighborhood of 18, higher than its historical average of 14.5 but not grossly so. But if you take out the financial stocks, whose P/E was under 10, you have an average P/E in the 20+ range, significantly higher than the historical average. But what if financing activities actually account for 30+% of S&P earnings? Now we’re north of the 21-22 neighborhood and approaching extreme valuations particularly given the inflation picture.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Part I: Introduction

What if, on New Year’s Eve of last year, you knew the following would take place by the end of October…
- New Home Starts would be down by over 30%…
- New Home Sales would be down by over 34%…
- Existing Home Sales down by nearly 20%…
- We’d have the first significant decline in home sales prices since 1930…
- Oil would be over $94/barrel…
- YOY gasoline prices up would be up 31%…
- Commodity inflation would be in excess of 15%…
- Food prices would be up over 17%…
- The US$ would be down over 9%…
- Earnings growth for the S&P 500 would be flat to down in Q3…
- And Consumer Confidence and Sentiment would be down 14 & 12 points, respectively…
What would you have predicted for equity prices?

But wait, there’s more…
What if you knew that a hand full of prominent hedge funds would implode by mid-year?
And that our nation’s biggest banks would have created these neat little entities called SIVs (Structured Investment Vehicles) for the purpose of taking advantage of mark-to-market accounting for pricing assets of questionable value - just the way Enron did a half a decade ago. And as an additional bonus, these SIVs allowed banks to move undesirable assets off their balance sheets to help improve financial ratios to meet reserve requirements – and when news of this broke, the equity markets saw it as a good thing and financial stocks rallied!

If you knew all of this at the beginning of the year, would you have predicted that by October, the Dow and S&P 500 would be trading at historical highs and the NASDAQ 100 would be up nearly 30% YTD. I certainly know I would not – which is why I’ve felt compelled to be out of the equity markets - which is a strategy this is finally paying off.

Part II: Account Performance

Here is how my performance measured up to the averages on a YTD basis through October:

PORTFOLIO	YTD RETURN
The MAC’s Core Portfolio	7.2%
The MAC’s Focus Portfolio	3.4%
S&P 500 (VFINX)	10.8%
NASDAQ 100 (QQQQ)	27.9%
Benchmark	9.3%

When I first sat down to write this update on Thursday, I wrote the following: “The last few months have been profitable for your portfolios as the market begins to price in inflation and credit risks but we still have a little catching up to do before I reach parity with my benchmark. But as I sat down to finish my market outlook over the weekend, I downloaded updated account information to find that we have finally caught up to our benchmark after a strong showing in the first couple of days in November. As of the close of business on Friday, my “Core Portfolio” was up 8.7%, just a 1/10th of a percent below my benchmark which is up 8.8%.

While I’m certainly not satisfied with my performance on a YTD basis, the returns in your account for the second half of the year are fairly impressive thus far. I appreciate your patience with my investment strategy and I’m glad that you are finally enjoying some appreciable gains.
Read the rest of this entry »

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

The purpose of this webpage is to provide a dynamic source of time-sensitive research that supports our macro Market Outlook.

For some time, I have theorized that our economy would gradually enter a state of stagflation. While the majority of Wealth Managers held onto hopes for a “Goldilock’s economy”, I created an investment strategy based on stagflation which provided above average gains in 2007 and appreciable gains in 2008. In my Market Outlook, I explain in detail the rationality for my theory and why most wealth management firms have their clients woefully ill-prepared to profit from such a set of circumstances.

I originally posted an article on April 17th, 2007 regarding the probability of a Goldilocks scenario versus Stagflation.

I’ll attempt to update the following table the day after the government’s release of the CPI & PPI figures each month.

INFLATION DATA	2007	2008 YTD	Annualized	Hot/Cold
CPI (2)	4.3%	1.4%	4.2%	Hot
Core CPI (2)	2.4%	0.9%	2.7%	Warming Up
PPI (2)	6.7%	2.6%	7.9%	Hot
CRB Energy Sub-Index (2)	39.5%	28.0%	83.9%	Texas Asphalt in August
CRB Foodstuffs Index (2)	21.7%	19.3	57.9%	Texas Asphalt in July
CRB Index (2)	20.6%	12.6%	37.9%	Smokin’
Wage Inflation (1)	5.0%	1.0%	4.0%	Hot
Unemployment (1)	5%	5.1%	N/A	Moderating

ECONOMIC DATA	2007	2008 YTD	Annualized	HOT/COLD
ISM Index (2)	(3.7%)	(3.6%)	N/A	Contracting
Construction Spending(1)	1.7%	(2.5%)	(9.9%)	Cold
Consumer Spending(1)	5.8%	0.7%	2.8%	Cooling
New Home Sales(2)	(46.1%)	(26.2%)	N/A	Frozen
Existing Home Sales(2)	(21.4%)	(13.9%)	N/A	Ice Cold
Durable Goods Orders(2)	(2.8%)	(7.7%)	(23.0%)	Frosty
Consumer Confidence(3)	(21.7)	(26.3)	N/A	16 year low
Consumer Sentiment(3)	(18.3)	(12.9)	N/A	Cold

1. Data through March
2. Data through April
3. Data through May
Sources:
CPI, Core CPI & PPI: Data obtained from the Bureau of Labor Statistics.
Energy & Food Prices & CRB Index: Data obtained from the Commodity Research Bureau.
All Economic Data obtained from Bloomberg.com

I feel a little silly continuing to track this data as it seems fairly obvious where we are headed. If there were any doubt, the Fed has successfully removed it over the past 9 months with their aggressive easing while paying nothing more than lip service to the threat of inflation. Unfortunately, loose money always leads to inflation but it doesn’t always lead to economic recovery. In fact, the Fed is looking increasingly impotent which I addressed in Part IIIb of my April Portfolio Update, which you can read by clicking here . (Once you click on the link, you’ll need to scroll down the page.) Unfortunatly, the majority of wealth managers are betting on the old axiom “Don’t fight the Fed”, but it might turn out to be a loser’s bet. The Fed has all but promised to keep the liquidity pump primed but the consumer, housing and credit markets aren’t reciprocating in guaranteeing an economic recovery.

A word about CPI
Even though government reported inflation figures are heating up, I continue to maintain that they understate the reality of the situation – a sentiment that is becoming increasingly more popular. The following is a table of various inflation gauges so that you can make your own decision on this matter.

Inflation Gauge	Increase from 1/1/02 – 12/31/2007
CRB Index	149.8%
PPI – Intermediate Goods	41.4%
PPI - Finished	25.5%
CPI	18.9%
Core CPI	13.1%

As you can see, there is a remarkable disparity between real commodity price inflation and government reported inflation in Consumer Prices. Personally, I have a very difficult time believing that an explosive 150% increase in the price of commodities has only led to a meager 13.1% increase in Core inflation as the government reports. Since we know that the CRB Index doesn’t lie, then we can be certain that actual inflation in consumer prices has been understated. In my 2007 Annual Report to my clients, I included the following tidbits regarding the unprecedented commodity inflation in our economy:

• Currently, we are experiencing the highest rate of commodity inflation over any five year period – including the 1970’s. In 1973, the five year rate of inflation hit 99%. As of 12/31/07, it is at 103%.
• The last five years have been the only five consecutive years of positive commodity inflation since the CRB index was created in 1957 (Four was the previous record from ’71 – ’74).
• In three of the last six years, commodity prices have increased over 20%.
• In five of the last six years, commodity prices have increased over 10%.

In the 70’s, commodity inflation was like being kicked in the gut. Conversely, today’s commodity inflation is like a series of body blows from a heavyweight fighter. Once the global markets comes to realize just how substantial inflation really is, equity and bond markets will start to feel the pain that the consumers worldwide have been feeling for some time.

If you would like more information on how to protect your portfolio during a period of stagflation, please feel free to contact us.

The MAC is an Independent Firm that provides Wealth Management services to individuals, primarily those in or near retirement, on a fee-only basis. Our goal is to provide our clients positive absolute returns regardless of market movements. We believe that the majority of Wealth Managers focus on wealth creation regardless of risk while we prefer to focus on wealth preservation with an emphasis on risk-adjusted returns.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

PART I: INTRODUCTION

If the bear market has begun, expect gut-wrenching volatility from the market over the next few months. Two percent intraday corrections for the market will become commonplace.
- April Market Outlook -

When I suggested we would see “gut-wrenching volatility”, I didn’t even expect this. I expected 1-2% daily movements, not 2-3%. Market tops and bottoms are characterized by extreme volatility as the “C” words, contagion at the top and capitulation at the bottom, take hold of the market whipsawing it up and down. Market participants become very emotional changing their outlooks minute by minute.

Over the past quarter, most mutual fund investors were lucky to do better than break even while many hedge fund investors “took it on the chin”. Our portfolios did very well this quarter suggesting that if the market turmoil continues, I should be able to generate profits in your account. With that being said, I would not be surprised to see a short-term pullback in some of our positions as they have done very well and are probably overbought. But after recoiling, they could renew their advancement and I wouldn’t be surprised to see further strength, especially in our commodity positions.

Here is how my performance measured up to the averages for the first quarter of 2007:

PORTFOLIO	Q3 RETURN	YTD RETURN
Core Portfolio	8.0%	4.5%
Focus Portfolio	7.9%	(0.4%)
S&P 500 (VFINX)	1.6%	9.1%
NASDAQ 100 (QQQQ)	8.06%	19.4%
Benchmark	3.1%	7.7%

PART II: CURRENT MARKET CONDITIONS

What is truly intriguing is the internals of the market…The last three months have not been kind to equity investors as the typical stock declined over 3.9%. Normally a declining market favors value stocks which are trading at cheaper valuation levels. This has not been the case in this decline. In fact the best “value” stocks dipped almost 11.8%. Meanwhile, the best growth stocks completed the investment surprise by advancing 4.1%.
Barry James, James Investment Research – 9/30/07

The substantial increase in market volatility is a sign that the bull market is either over or close to it. Read the rest of this entry »

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

The following news item regarding NovaStar Financial Inc., ticker symbol NFI, was released by the Associated Press today.

KANSAS CITY, Mo. (AP) — Mortgage lender NovaStar Financial Inc. said Monday it was terminating its status as a real estate investment trust, retroactive to the beginning of this year, after determining it could not pay investors a required dividend. The company’s shares plunged more than 21 percent after the announcement.

Back in February, right the peak of the REIT market, I wrote about the fragile nature of REIT yields. If you have REIT exposure in your portfolio, I’d recommend checking out the post.

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Part I: Introduction - The Credit/Liquidity/Sub-prime crunch takes no prisoners.
Nothing, with the exception of US treasuries, has escaped the recent market turbulence unfazed. Here’s how various assets and indexes have performed since 7/19/07:

Asset/Index	% Loss
GLD	(0.7%)
SLV	(8.9%)
S&P 500 (VFINX)	(4.9%)
NASDAQ 100 (QQQQ)	(2.9%)
Emerging Markets (EEM)	(5.0%)
Total Global Stock Index (EFA)	(5.8%)

When I suggested we would see gut-wrenching volatility, I didn’t even expect this. I expected 1-2% daily movements, not 2-3%. This market is selling off quicker than I had anticipated which has me worried for individuals who are holding on to traditional asset allocations. Read the rest of this entry »

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

“This is the worst 5 days that [quant funds have] seen in the last 20 years.”
David Faber – CNBC – 08/08/07

If you would like to see the video, Click here to watch.

This morning, another CNBC commentator blamed part of the market’s problems on some Quant funds that have gone south which has led to people liquidating their shares. I’d argue it is quite the opposite - the market is going south which is resulting in Quant fund underperformance. Due to the irrational nature of the market, Quant funds should be expected to perform poorly. This was a theme that I started to watch in August of last year.

If you would like to take a look at my post from August ’06, simply click here.

My take on Quant Fund performance (or lack there of it) is merely another indicator that we are in the initial stages of a bear market. Two things take place at market tops that handicap Quant strategies.

1. Market Breadth deteriorates meaning the majority of stocks decline while a few large names hold up the cap-weighted indexes.
2. Investors are irrational during inflection points.

Read the rest of this entry »

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Part I: Introduction
Well, that was abrupt
- Johh Hussman, Ph. D., 7/30/07 -

This is how Dr. Hussman started an article titled “Market Internals Go Negative”. I have theorized that the upcoming bear market would not only be more severe than average bear markets but that it would happen more abruptly as well. This theory, which I’ve discussed in great detail in prior updates, is based on the historical precedence set in previous Secular Bear Markets. The developments of the past week have lent considerable creditability to this theme.

I am reluctant to call the beginning of the bear market, but it is looking increasingly likely that the all-time highs reached by the broad markets in early July may very well be the highest levels the equity markets see for a few years. There are several things that need to occur to confirm the bear market, but if these events take place over the next few weeks, then I’ll tweak a few positions in your portfolio to better take advantage of a full-fledged bear market.

Part II: Performance Update
July was a good month for our portfolios as my Focus Strategy gained 4.2% and my Core Strategy gained 3.2% while the S&P 500 loss 3.2%. While one month’s performance is a relatively benign predictor of long-term results, the trends that have gained considerable traction over the past several months bode well for my long-term strategy. If these trends continue, I expect to see considerable appreciation in your account.

Here is how my performance measured up to the averages on a YTD basis through July:

PORTFOLIO	YTD RETURN
Core Portfolio	(0.6%)
Focus Portfolio	(4.5%)
S&P 500 (VFINX)	3.6%
NASDAQ 100 (QQQQ)	10.4%
Benchmark	3.9%

We did a fair amount of catching up but we still have more to do – and if the market trends continue, I think we could catch up quickly.

Part III: Market Outlook
As I discussed in my previous update on July 24th, several trends have emerged that I have been anticipating. In addition to the themes I discussed in my last update (click here to read – or just scroll down as it’s the entry just prior to this one), several more developments have taken place in the short span of a week. I’ve added my editorial comments in italics.

• 7/31/07: American Home Mortgage – AHM - falls over 90% in one day. This trend will continue to have a devastating impact on financial stocks. IYR is now 18% below its February peak.
• 7/31/07: Sowood Capital Management liquated its two funds after suffering devastating losses in excess of 50%.(Read more below)
• 7/31/07: West Texas Intermediate Crude (CL) rose to an all-time record close of 78.21. The crude contract appreciated over 9% for the month. I’ve previously addressed the inevitable increase in Oil prices. (click here to read) I’ve positioned your portfolio to indirectly take advantage of energy prices by investing in Gold and Silver (PMs) but so far the PMs have shown a higher correlation to equities than they have to Oil and other commodities. This is highly unusual and at some point, the historical correlation between the PMs and other commodities will be reestablished.
• 7/31/07: The CBR Index increased 3.5% in July and is up 7.5% YTD. Obviously this is inflationary. The CRB index typcially appreciates more in the second half of the year than the first half. Currently, it wouldn’t be surprising to see the CRB index increase 10+% in 2007.
• 7/24/07: The US$ hit a new low on its trade weighted index, dancing with the critical support level of 80 before rallying at the end of the month. As of the close of business today, the US$ index is 1% from its critical support level of 80. The US$ was down 1.5% for the month. I keep hearing about market volatility, but what hasn’t got much media attention is the Yen volatility. 1% daily movements have become common in the last couple of weeks. If the Yen Carry Trade is wiped out – watch out!
• 7/30/07: Technical leadership in equity markets experienced a precipitous decline over the 5 previous days finally pushing this critical bear market indicator into positive territory. The extent of the decline has only been matched twice since the mid-1960’s. (Source: Investech) Seven of 11 indicators on my “Bear Market Hunter” are now signaling a bear market. The other four are neutral with a couple very close to being bearish.
• 7/31/07: Market volatility, measured by the VIX index, has more than doubled since Q2. An increase in volatility is typically a pre-cursor to a change in market direction. The DJI swung from a 100+ point gain to a 140 point loss in today’s trading action.

I came across an interesting article titled “The Crash that Could Come” which reinforces the themes I’ve positioned your account to take advantage of:

Investors and ordinary citizens have good reason to worry about a perfect economic storm: [1] A deepening loss of confidence in the dollar leading to higher interest rates, [2] the higher rates bringing a crashing end to a hedge-fund, private equity, and merger binge that has depended heavily on cheap borrowed money; [3] the boom in bait-and-switch mortgages ending in a morning-after of rising defaults and sinking housing values; [4] inflationary pressures in food, oil, and other commodities leading to still higher interest rates – all unsettingling stock and credit markets and putting a new squeeze on consumers borrowed to the hilt.(emphasis mine).
Robert Kuttner – Boston Globe, 7/30/07

In the movie A Perfect Storm, it was the confluence of 3 minor storms that created one devastating storm aptly called “The Perfect Storm”. Mr. Kuttner names four minor threats to our markets that when compounded could lead to devastating losses in equity and bond portfolios.

Another one bites the dust…
Strike up the Plano, Texas Senior High Band cause the school’s fight song is going to be the mantra for Wall Street and its Hedge Funds. Sowood joined the fray of Hedge Fund’s gone bad as it announced it is liquidating its two funds. (I’d provide a link to their website, but it would futile as it has already been taken down.)

Sowood, founded by a couple of smart guys from Harvard, liquidated itself after suffering 50% losses. Their portfolio primarily consisted of junk bonds. Not that CDO stuff that ravaged Bear Sterns but good ol’ run-of-the-mill junk bonds. What’s the difference? There is a liquid market for junk bonds where there is not one for CDO’s.

Bear Sterns pointed to the lack of liquidity as one of the primary reasons why their fund imploded. For the last 12 months, I’ve warned about a Hedge Fund Scandal and it is becoming increasingly apparent that one is inevitable.

Part IV: Conclusion

The next few weeks and months will be interesting (and with a little bit of luck, profitable as well). If the bear market is upon us, it should be confirmed soon. The one concern I have is the behavior of the PMs. While inflation pressures persist, somehow inflation expectations are tepid. As soon as I see evidence that the PMs have shook off their correlation with equities, the trend reemerges. (Quite frankly, it’s becoming very annoying.)

This is not natural for PMs and at some point, they will reestablish their correlation with other commodities. When that occurs, we should do very well. Until then, I’m not exactly sure how our portfolios will perform. The impetus behind the equity sell-off has been a credit crunch and it’s taken the PMs with it.

I appreciate your patience and loyalty and I’m relatively certain that you’ll be rewarded over the next 12-24 months. As always, please do not hesitate to call me if you have questions or concerns about your account.

Matt

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements .

Just wanted to give you a quick update on our portfolio which has experienced some positive action lately – FINALLY!

After today, My Core Portfolio is almost back to even. The Focus portfolio still has some catching up to do but given how I have it invested, it won’t take long with many more days like today. I’ll report YTD figures at the end of the month.

The trends that I have been anticipating have started to emerge over the last couple of months. Several of these trends have accelerated over the last several weeks. Our portfolio is positioned to take advantage of these trends and has appreciated nicely. Of course, the market is still up for the year and I’m down so we have some catching up to do.

The key trends that have emerged are as follows:

1. The US$ has broken through its previous multi-year low at 80.39. For all intent and purposes, this represents the US$’s all-time low. It was lower at one point but that was before the introduction of the euro which was then substituted for several European currencies. As I said in my quarterly update, I am surprised by the timing of this development as I expected it would take place but only after the Fed hinted at lowering rates and inflation data subsided. Practically, every position in my portfolio benefits directly or indirectly from a falling US$.
2. The sectors that I feel will lead the market down continue to underperform. Small-caps, Financials (IYF), REITs (IYR) and Utilities (IDU) have significantly underperformed the market. These sectors will be the hardest hit during the next cyclical correction. The following is an update on how these sectors have underperformed the broad market.

Ticker	IYR	IDU	IYF	S&P
Peak	94.57	104.35	129.54	1539.18
Current	74.27	96.13	109.73	1511.01
% Loss	(21.5%)	(7.9%)	(15.3%)	(2.7%)

3. The PMs (Precious Metals) have seemingly reestablished their historical non-correlation to equities. As you know, one of my biggest fears has been a liquidity crunch that would lead to depreciation in all asset prices – equities as well as the PMs. The recent behavior of the PMs has served to alleviate some of my apprehension about being invested heavily in this space but I’m not entirely comfortable just yet. The PM stocks have still shown an annoying correlation to equities rather than the Metals but this should eventually correct itself.
4. Bond Yields continue to stay elevated as the market comes to grips with the reality of inflation in the marketplace. As I said in my Quarterly update, the disconnect between inflation pressures and inflation expectations has been the primary cause for losses in your account. It seems that Wall Street’s denial of the reality of inflation is gradually coming to an end.
5. From a technical standpoint, market breadth continues to deteriorate but is not quite signaling a bear market. Today, declining stocks outnumbered advancers by a more than a 6:1 margin. Leadership could be best described as bi-polar. The number of highs versus number of lows has been close to even over the last several weeks despite major indexes hitting new highs. Last month, I discovered a new indicator called the Hindenburg Omen. This has come up positive every day for the last 5. The homebuilders, which I warned about in April, have been destroyed the last several weeks. The I-shares Homebuilders Index ETF (XHB) fell 4.5% today to a fresh 52-week low.

I’m encouraged about the trends in the market place and I believe that over the next 12-24 months, our portfolio will appreciate substantially if these trends continue. With that being said, several of our positions are a bit overbought in the short-term and I wouldn’t be surprised or discouraged to see us give a little back over the next month or so. I’ll provide a more in-depth update at the end of the month. As always, please do not hesitate to contact me if you have any questions or concerns about your account.

All the best,
Matt