RISK PREMIUM: HOPE FOR THE BEST, BUT PLAN FOR THE WORST

For The Week Ending:  August 1, 2008

A WEEK CHARACTERIZED BY HEAVY VOLATILITY

The market direction based on our Risk Premium model still points toward a lower trend in stock prices.  This bearish sign is even more significant because the total risk premium for all three Dow Jones indexes is on the rise.  For the week ending August 1, 2008, the Dow Industrials fell 43 points (a nominal 0.38%), closing the week at 11,326.32.  The Dow experienced wide swings, reaching a mid-week high of 11,583.69 but was unable to hold on to its gains. At one point it was off 257 points.  Because of this extraordinary volatility, in our judgment, investors would be well advised to select stocks using a very short-term outlook, perhaps using option strategies to partially mitigate market risk.  With the market so volatile and with significant moves in both directions, we would not be surprised if the recent lows were tested again.  Thus investors should be highly selective and sensitive to values.  Plan for the worst and hope for the best.

THERE IS NO REASON FOR STOCKS TO MOVE HIGHER

The bearish pattern in stocks is underpinned by adverse trends in key economic areas, notably:

(1)OIL  The continuing high cost of oil, despite a  recent drop of more than $20 a barrel from its earlier summer high, is taking a heavy toll on the economy.  On June 20^th, 2008 we commented that “We expect that the volatility and persistent increase in the price of oil may subside during the next 12 months, perhaps heading down to $100 to $120 barrel.”

(2)CREDIT The credit crisis continues to constrain capital investment despite the fact that money is cheaper.  The availability of credit remains tight for corporate and consumer borrowers alike.

(3)HOUSING The abundance of housing inventory and dropping home values (a drag on personal wealth) show little sign of abating, especially in the near-term.

(4)INFLATION/WEAK DOLLAR The Federal Reserve is likely to increase interest rates, probably following the presidential election this November.

(5)POOR QUALITY LOAN PORTFOLIOS Many financial institutions continue to be plagued by troubled loans on their books that may not have been written off yet.

(6)CORPORATE EARNINGS Year-over-year earnings have generally been lower, notwithstanding the fact that they may frequently be better than Wall Street’s expectations.

Unless and until these areas of the economy show signs of improvement, there is no sound reason to be optimistic about the market. Our Risk Premium Index reflects this bearish sentiment. The Dow’s continuing flirtation with the 20% threshold number needed to declare an official bear market may lead some to conclude that we are not truly experiencing a bear market.  But if we are not officially undergoing a bear market it sure feels like one.

RISK PREMIUM INDEX REVISED

We recently made certain adjustments to our Risk Premium model in order to reflect the deficit in earnings per share reported by the Dow Jones Industrials ($81.34) per share loss for the week ended August 1, 2008, as compared to $132.14 for the previous week and $827.44 a year ago.  As a result of the Dow Industrials’ earnings falling into the red, the value and usability of working with a P/E multiple which is effectively zero would lead to erroneous conclusions.  We have corrected the model to allow for risk premiums to fall below zero. When this occurs we multiply the resultant number by minus one and add the risk premium which is above and below zero to arrive at a Total Risk Premium.  This adjustment has the effect of smoothing out the data lines in the Dow Industrials, Transportation, and Utilities indexes.        

RISK PREMIUM STATISTICS

§         The Industrial Risk Premium ended at 8.05% versus 8.22%

§         The Transportation Risk Premium decreased to 8.02% from 8.10%

§         The Utility Risk Premium decreased to 6.73% from 6.85% n

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