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Perhaps the Fed does really get it after all. At the last meeting in December, the communiqué released at the end indicated that though strains in financial markets had increased since the previous meeting, higher energy and commodity pricing was likely to put upward pressure on inflation. Thus, with these comments, the Fed signaled the vigilance with which it was observing inflation potential and underlined their conclusion that moderate growth was likely to return. In the minutes of the meeting however, it remains surprising how behind the curve they appeared to have been. In the commentary concerning the housing sector, they mildly acknowledged, "…that the housing correction was likely to be both deeper and more prolonged than they had anticipated in October." Furthermore, the abrupt fall in this sector "…could put additional downward pressure on prices, leading to a greater decline in household wealth and potentially to further disruptions in the financial markets."

There appeared to be little recognition by the Fed of the dire financial difficulties being experienced worldwide: huge losses by banks threatening liquidity ratios, a crisis in homeownership, and falling consumer spending to name just a few. Since the summer, several banks and investment institutions both here and abroad have written off cumulative losses mostly in the sub-prime market totaling in the billions and the resultant lending restrictions between banks has caused credit markets to seize up. In order to counter this seizure, massive liquidity injections by central bankers around the world including naturally, the Federal Reserve, were triggered, and rules outlining acceptable collateral for these borrowings were loosened considerably. However despite the turmoil, the Fed persisted in their view that this was a temporary problem that could be resolved and that growth would be only moderated as a result.

This week, Fed Chairman, Ben Bernanke, stated that recent incoming information has altered the outlook for the economy in 2008 and "… downside risks to growth have become more pronounced." His speech was a warning shot across the bow to financial markets that the Fed was no longer a disinterested spectator but instead would take an active role to promote growth. These comments should be taken as a signal that the Fed is prepared to make additional interest rate cuts starting at the first FOMC meeting of the year in the final week of January and this could mean a cut of 50 basis points.

With pronounced slowing in manufacturing, still declining housing markets, a significant jump in unemployment numbers and rising credit delinquencies, the probability of recession is greater than it has been in years and could be immune to any action by the Fed. Their actions this week only serve to emphasize just how behind the curve they really are and ironically, it reminds us of how Japan struggled with many of the same problems at the beginning of the 1990’s, which we were told would never be repeated here. Now we question whether the fiscal and monetary policy response will be the same as Japan’s.

Technically Speaking

Trading volumes were quite strong in this first full week of 2008 and though the week ended with a loss, bulls will be consoled by the trading activity on Wednesday and Thursday, both up-days on heavy volume, which appeared to signal that a bounce was imminent. Generally, markets are vastly oversold at this point and stochastics are now on the rebound. Friday’s losses on all major markets remained contained within the week’s trading range ensuring that Wednesday’s closing reversal stood as the leading event of the week and likely to be the guiding signpost into the next week. A bounce here, though likely, should only be viewed as a bounce off an oversold condition. We do not expect an alteration in the current downward market bias.

The broader markets, the Dow Jones Industrials and the S&P 500, are trending downward from their respective peaks in October with lower highs and still lower lows. With S&P at its current level of 1401, a bounce is possible with a ceiling around the 1460-1470 area. Similarly, a bounce on the DJ-30 could produce a gain of several hundred points from the current 12606 to 13370, the site of its 200-day moving average.

The tech sector, and especially the Nasdaq-100 which has no financials in its composition, is better positioned to profit from a bounce at this juncture. A move toward its 200-day moving average would place the Composite index around 2600 while the Nasdaq-100 could find itself around 2050 and well above its 200-day moving average, which is located now at 1991.

New Buy Recommendations (in order of preference):

None.

New Short Sales

None.

Stock Positions to Sell/Exit:

Our longs were pared this week down to two stocks as stops were touched on the other four stocks.

Portfolio Comments:

New stops have been added to the list while others have been modified. Those that have blanks are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

N.B. There are no longer restrictions on foreign stocks held in Canadian retirement savings accounts.

¹ Peabody Energy spun off its coal assets into Patriot Coal on Oct 31 at a ratio of 1 share of PCX for every 10 shares of BTU held.

New stops in BOLD

* Stop on a closing basis

** Buy if above entry price

*** Split-adjusted price