I was quite amazed at the amount of negative response received from European posters on the ECB post. I still believe the ECB is making a mistake. Granted, the ECB is dealing with a host of issues the FED does not have, such as, semi-rigid labor markets. I still believe the ECB’s target and potential slavish adherence with keeping to an inflation target will cause a lot of unnecessary pain to the Euro zone.

Blow-Off Top: Oil

We are not the biggest fan of technical analysis. Yet on the flip side, all investing information should be taken in and evaluated. We have run across the following pattern from time to time with individual stocks. We have laid out the definition below. We are wondering if the large spike in oil could fit this category.

The last two days have been very interesting to watch. Interesting enough for us to take the time and post, which has become the exception to the rule. Its seems the duo of Paulson and recently added big gun Bernanke had started to make head way against the dollar/oil imbalances, until yesterday.

In swoops Trichet. Was this the same Trichet yesterday that urged citing the dollar during the G7 meeting and subsequent press statement? The same Trichet that has been harping the US about the low dollar in several noted press conferences. In the past it has seemed that world central banks have worked together. Is Trichet trying to assert the new found global power of the ECB and his speaking platform? Although central banks are-- supposedly-- independent entities, we would argue that they are political entities into themselves.

We live, breath and eat this stuff, so it is odd to think that not everyone’s life revolves around the financial markets. Can you even imagine? In our 3 years of managing money under Lenger Asset Management we have never received market driven calls till yesterday. This is even odder, since we have a small client base. For us it is an interesting indicator that fear has reached Main Street. In the past this has signaled a good entry point. The first leg of the down draft could be over. However, let’s take a moment to review the past portfolio, current situations and view moving forward.

We have been making some serious changes in the portfolio, since last post. The following numbers are rough estimates over the early fall. We had been operating off a strong cash base (11%) and had a very strong weights in Large Caps with bias on Growth (IVE & IVW) (62%), International (EFA)(15%), Mid Cap (IWP & IWS) (4%), High Yield Bonds (HYG) (4%), Currency (DBV) (1%) and Commodities (DBC & DJP) (3%). Our case was that things were going to get worse.

Per our previous post we had noted that our portfolios have been moving to higher risk assets.

Just for a quick update: In the last 2 months our recent additions to the Max Growth allocation are 4% in high yield bonds (HYG), 2% in small cap growth (IWO), 6% in small cap value (IWN) and only 5% in cash.

Our portfolio continues to shift into riskier assets, as the real estate and credit markets continue to scare investors and cause the markets to sell off.

We first purchased iShares Russell 2000 Value Index (IWN) on November 7th at $71.90. From an intraday high of $85.67 on June 1st to the purchase price of $71.90, this small cap value was down 16%. We have a set limit order for just under $70 in order to average down should the index retreat further. Yesterday, it touched $70.04.

WOW!!! It has been on hell of year this year and the last few weeks have been no exception.

Prior to the big rally we had sold our 2% short position in (SH) and bought (IWN) small cap value. When we had a look at the asset class it was down roughly 16% from peak and other asset classes had not even come close. Granted it was only a 2% position again. We wanted to leave room to pick up a bit more on the down side, which, given the look of yesterday's market and today’s futures might just happen.

It would seem that our 2% weight in (SH) Short S&P 500 was a bit premature. As noted earlier, we took a small position with room to move up. Our current position is down 1.4%. The S&P 500 (non-total return) is up 10.35% YTD.

Here is the the crux of the situation. Has the market rallied too much before earnings season? From all we can gather, everyone expects earnings to be excellent and propel the market forward. Said another way, earnings will be great and the market will be perceived as cheap. Also, the market seems to be baking in further interest rates, which deviates from the credit markets view.

We recently where asked by our largest client about the effects of the Canadian dollar on a private placement we are helping to facilitate. In the process of drawing up our broad strategy post placement we outlined a brief look into our current economic thinking. We thought readers might find it interesting.

The recent cut of 50 BP in the Feds Funds rate has caused the dollar to move sharply lower. Currently, the trading in short term Treasuries indicates the possibility of future cuts in the months ahead. It should be noted that this may be a poor indicator currently, as opposed to previous readings. In part due to the recent credit crunch driving treasuries lower in a flight to safety and need for liquidity with the absents of commercial paper. Should the FED continue to cut we see a continued slide in the dollar.

We would have liked to see a 25 basis point cut. We wanted to take a few days to think about what had transpired before posting. Luckily, the most recent inflation numbers came in below expectations, but initial claims dropped as well. What's a central banker to do? In the short term we believe the Fed moved with 50 BP to shore up against current investor nervousness in the market.

It is still our firm belief that an economic pullback would be good for the long run growth of the economy. We don’t see rates falling much further. Bernanke laid it out in Germany (see post). We quote:

We have not had a chance to read the book and may not for another 3 weeks. However, we have been diligently reading the comments and interviews flowing across the media networks. This morning we pick this up from Cnn Money.

How would you judge chairman Ben Bernanke’s response so far?

It is that dreaded bank run, but this one happened to be a mortgage company in England. We find this a bit weird to see in a country like England. The Bank of England stepped in with a direct loan to bail out Northern Rock. And lucky for us, the Fed stepped in behind the scene by lowering the rate at the discount window and allowing U.S. banks to push capital through to their affiliates. Was there some wisdom behind Glass Steagall Act after '29? (Glass Steagall Act post)

Happily, we don’t have these pictures all over our news. The US consumer can chalk it up to a foreign issue. That is why the confidence numbers where so important last week. If we see a major bank failure in the US, we are in for some serious rough waters.

Earlier in the week Fed chief Ben Bernanke gave a speech at the Bundesbank in Berlin, Germany. The vast majority of commentators dismissed it as Bernanke basically saying nothing. We're not sure what they read or heard, but we obtained a great deal of information from the Fed chief's speech. We would recommend everyone read it. (Bernanke Bundesbank Lecture) We have taken a few excerpts and placed our comments below. With the initial claims out yesterday, we still only see a 60% chance for a 25 basis point cut.

My reading of recent developments is that although some of the details have changed, the fundamental elements of the global saving glut remain in place. Most important, the emerging-market countries and oil producers remain large net suppliers of financial capital to global markets.

The downward unemployment revisions in June and July confirm what we had suspected for some time. Employment was and will continue to slow. Given all the economic data recently, we are of the opinion that a 50 bp cut in Fed Funds happens by year end followed by another 50 bp cut into next year. We had held out that there was a strong possibility for them to hold for the current meeting. We are now shifting to a 60% cut and 40% hold for the current meeting.

It is our thesis that the economy was on a good course until the short term credit crisis. A lower dollar happens to help the Fed at this point. We see a few short term drivers working on the dollar. The first being the strong influence of lower rates pushing the dollar down. However, a dollar collapse will be prevented from the demand for US goods and the desire for US Treasuries (demand being driven from European short term credit insecurity). We still advocate Large Cap position with a bias toward Growth over Value iShares S&P 500/BARRA Growth Index Fund (IVW) and iShares S&P 500 Value Index Fund (IVE).

With yesterday's move, we suspect that the market will drive back into negative territory. Our new short term market thesis is for for a tough September. Third quarter earnings could get dicey. iShares iBoxx $ High Yield Corporate Bond Fund (HYG), the high yield ETF, seems to be performing well during this market volatility. PowerShares DB G10 Currency Harvest Fund (DBV) seems to be moving back down with the rotation in and out of the carry trade. We did not have the opportunity to take the 1% position, since it was up 1.5% the following day. We will continue to eye DBV for a potential entry.

READ THE ARTICLE FROM Peter Eavis!!!!!!! (Fed Bends Rules to Help Two Big Banks) If you are interested in economics and US financial markets at all, the need to understand the legal framework and how the banking system operates is essential, as that is at the heart of the whole system. We have cited a small bit from the article:

The regulations in question effectively limit a bank’s funding exposure to an affiliate to 10% of the bank’s capital. But the Fed has allowed Citibank and Bank of America to blow through that level. Citigroup and Bank of America are able to lend up to $25 billion apiece under this exemption, according to the Fed. If Citibank used the full amount, “that represents about 30% of Citibank’s total regulatory capital, which is no small exemption,” says Charlie Peabody, banks analyst at Portales Partners.

The intra day low on the S&P 500 was 1370.60 on 8/16 and yesterday the intra day high was 1464.86. That is a 6.87% move in 5 days! However, from close 8/16 of 1411.20 to close yesterday of 1464.06 we have moved 3.75%.

We have been publishing posts on this site for 4 months. It has been a fascinating journey into marketing oneself, spelling and grammar corrections by others and serious hesitations about publishing market comments. One of the bi-products of running a financial blog is seeing the stats being produced. It is some real big-brother-1984-style monitoring.

We have been advocating this all along. However, it does not inject liquidity to the consumer directly, who are responsible for two-thirds of the economy. The Fed must still see an extremely hot economy with embedded inflation. Bernanke does not seem to want to cut the Fed Funds Rate until the proof is on the table.

Currently, we are not in the frame of mind to chase this market. However, we would like to drop our cash position to or below 10%, if the market stays flat before the FED meeting. We also think that there is an additional possibility for the market to drop back toward the 10% technical level, where it would be nice to deploy cash. In the end it may be best to sit tight and watch today’s action.