My summary opinion is that I still expect prices to move out to new highs by the end of the year but I’m not really excited about the quality of this advance, so far. On the surface, we are looking at very typical initial thrust up off a good low. Prices have moved higher in duration and magnitude consistent with other broad based rallies since this bull market began in 2003 (roughly 5% in 21-26 days). Participation is broad as the rally includes many of the key sectors like financials, technology, healthcare and consumer groups. However within these breadth measures, I still find a suspicious layer of selectivity which again is the hallmark of a bull market in its final phase. According to the fine work of Jason Goepfert of Sentiment Trader, the number of 52 week New Lows in the NYSE index has stayed stubbornly and extraordinarily high in the face of this advance. Jason did an excellent study of the “normal” number of new lows seen after a 5% advance in the broad market which you can view in the chart of the week. For this bull market (since 2003) after advances of 5%, the average number of new highs is typically 267 and the average number of new lows is 18. Today we are showing 139 new highs and a very high 131 new lows. For those who can stand double speak, the new highs are too low and the new lows are too high for this stage of an advance. As you can see, we have an odd situation that characterizes this advance as broad based in sector participation but still highly selective within those sector moves. The energy, financial and industrial sectors seem to have the least amount of selectivity inherent to the buying pressure.

Beyond selectivity, I am closely watching volume numbers for confirmation that this rally is going to continue higher. According to Lowry’s, net upside volume is still well below the July/ August peak while prices have already reached that level. The best thing that could happen here would be to see prices and New Upside Volume break out together. Until then, we hold off on any new commitments. This is where failures occur with non-confirmation of key indicators like volume. If prices were to decline from this level on heavy volume, traders would get spooked into selling and our uptrend would at least stall temporarily or at worst end completely.

Finally, since prices have retraced to their July/ August peak, we can take a reading on overall buying and selling pressure to compare where we are today versus these same price levels 2 months ago. Today total buying pressure is a full 143 points lower and selling pressure is 185 points higher than they were in July. That’s a huge difference by the way as these indicators might move 5-10 points on a big market day.

Unless the quality of this advance improves, I am still going under the assumption that this uptrend is probably just another late stage run in a bull market that is running out of steam. Can we make new highs before year end? Certainly. But again, if the character of this advance does not improve, a new price high in the broad market may also be one of those moments in history that we look back on and say “wow, that last rally really sucked in a lot of investors that didn’t know any better.” At this point, there are no glaring warning signs or divergencies between price and the internal condition of the market to warrant immediate action. Let’s just say, I’m on pins and needles and taking the pulse of the markets daily.

Bonds are trying to find a bottom in here and I think it makes sense to begin looking for good entry points to migrate stock money to bond money. The Ned Davis Balanced Model has recently decreased their allocation to stocks from 60% to 40% and raised their bond allocation from 20% to 40% leaving the rest in cash. Without consideration for age or risk tolerance, I would generally agree with that asset allocation model. A move above 4.67% on the 10 year bond wouldn’t be a good thing for any segment of the market but for now it seems like this level will hold and bonds may have a good run up soon.

For the remainder of this update I want to reiterate the objectives, focus and recent changes to our primary investment strategies. I find that it’s a good periodic exercise for all involved just to confirm that you are where you should be in terms of strategy allocations.

Worldwide Sectors (Relative Return Strategy)
This is our aggressive strategy. As of April this year, I have retooled this strategy to be more aggressive than it has been in the past by eliminated the hedging (shorting) component. In review of my trading history with hedging this strategy I found that I was simply doing more damage than good by hampering gains. This strategy generated gains by rotating assets among leading sectors that are in intermediate term up trends and outperforming the S&P 500. I am attempting to keep this strategy 60% invested or more during primary bull markets and as such the volatility will be substantially higher than our other core strategies. Investors in Worldwide Sectors should be able to tolerate a 7-10% decline in the value of their investments and is more appropriate for longer term time horizons (read younger clients). The objective of this strategy is to outperform the S&P 500 over 3-5 year periods while still protecting capital against more significant and protracted bear market declines. If you are looking for bigger gains than our “absolute return” strategies offer, you need to have an allocation to Worldwide Sectors.

All Season (Absolute Return Strategy)
Our Flagship investment model attempts to make money in all market conditions and maintain positive calendar year results. Risk management is a priority while earning respectable returns. However, the strategy will almost always lag the broad markets during strong bull market phases as we attempt to capture 70% of the broad market’s gains and avoid 90% of the losses. Investors can expect draw downs (periodic losses) of less than 5% while we attempt to earn a long term average return of 10% net of all fees. Almost all of our clients have investment allocations to this core strategy either through our new All Season mutual fund (IASFX) or our separate account version of the same strategy.

High Income
This is our income strategy that attempts to capitalize on the best risk adjusted returns available in the bond and income markets. This strategy has a heavy emphasis on corporate (junk) bonds but has recently been enhanced to include traditional treasury bonds (long or short), municipal bonds, short term bonds and floating rate funds. This strategy does not invest in any fixed income securities as much as variable rate securities that offer substantially higher yields but also carry some manageable price risk. This strategy is a nice compliment to both Worldwide Sectors and All Season as it will excel in periods of rising bond prices or recessionary cycles.

New Power
Our newest and boldest strategy is as much of a fundamental play as a technical one. This strategy invests in the top performing alternative energy stocks (8-10) and attempts to pick up the leaders on any pull back in price. Stocks are sold if an alternate can be found that offers greater upside potential and a low risk entry point. This is not a risk management strategy by any stretch or comparison to our other strategies and investors should be willing to tolerate losses of 10-15% once or twice a year. For instance, YTD the strategy is up over 20% net of fees but has experienced two declines of 15% so far in 2005. Investments will be made across the spectrum of sectors tied to the alternative energy market including, but not exclusive to, solar, wind, hybrid technologies, turbines, hydro power, and conversion devices.

Please feel free to call us directly if you are interested in any of the above or believe that you’re allocated incorrectly in any way. We are reaching out to all of our clients over the next 3-6 months in an effort to make necessary adjustments, offer our new financial planning and wealth management services and generally touch base after a long cycle of restructuring. Thanks to all and have a great week.

Sam Jones