In case you missed it, reader G.H. commented on last week’s Fund Tracker update as follows:

This might be a good time to point out that buy and hold (hope) “lazy portfolios” diversified across asset classes and countries are not doing so well.

There will be no place to run/hide except in shorts when the lights are finally put out on the credit party.

I have to agree with his view. This reminded me of Paul Farrell’s recent article with the subtitle “Ten resolutions that will help you survive the coming bear market.” He offers 10 resolutions and ends by saying that you should “play it conservative, because 2008-2010 will repeat the harsh lessons of the 2000-2002 bear-recession.”

While some of his resolutions are sensible, others are not. He continues to suggest investing your nest egg in low-cost, no-load index funds. While that makes sense in a bull market, Paul obviously has not learned from the lessons the last bear market has taught:

A bear market needs to be avoided at all costs, or you will again join millions of mislead investors who will watch their (bullish) portfolio sink into oblivion. To say investing for the long-term is the answer when buying and holding is simply not acceptable, because who wants to go down with a bear market and then wait some five or more years just to make up the losses?

I have heard from readers who went down with the last bear market holding low cost index funds, and who have struggled to get back to even. Some had to postpone their retirement indefinitely. Maybe this whole issue of bear market avoidance makes more sense to you if you realize that your financial life is much shorter than your physical life. It’s one thing to let your portfolio slide 50% when you’re in your in your 30s, but it quite another to do so when you’re in your 50s or older.

There is not enough time to make up the losses. Remember, we are all working against a deadline, which for most people is retirement. Don’t mess with bullish investment strategies in a bear market and vice versa, because you will pay the price via a hefty portfolio haircut.

2007 was the year when Wall Street acquainted you with a host of new terms ranging from CDOs, SIVs and RMBSs among many others. One of the more common ones, which you can read about in the news every day, is “write-downs,” which is simply another way of saying ‘losses.’ However, it sounds so much more sophisticated when a company announces some $8 billion in write-downs as opposed to saying we lost $8 billion with Subprime investments gone bad, don’t you agree?

Good news! Now you can elevate yourself to that same level when discussing personal issues with friends at a party or with your better half. It is bound to surround you with an aura of distinction and sophistication. Kevin Depew of Minyanville shares his experience of how he integrated this term into his lifestyle:

Late night I was forced to disclose more than $1,275 in additional writedowns tied to the subprime mortgage mess, and the failure of certain horses to run as expected at Aqueduct, including the collapse of the 8 horse in the 9th race despite having a three-length lead in deep stretch. I mean, who gives up that kind of lead in deep stretch? The horse was literally running backwards in the final furlong!

Following last night’s disclosure of additional writedowns, investors (Hi, Honey, I love you!) called an emergency board meeting with one of her sisters to discuss my exposure to subprime mortgage products, the OTB and whether I would be able to retain control of the firm’s debit card. Meanwhile, I am still scheduled to meet this afternoon with Independent Banker, the 8 horse in the 7th at Churchill (seriously!), who is listed at 15-1 in the morning line. However, the possibility of additional writedowns related to subprime mortgages, and the difficult outside post given Churchill’s one-turn mile, cannot be completely ruled out.

The markets greeted the first trading day of the New Year with a sharp sell off, which picked up even more steam towards the end of the week caused by yesterday’s chilling jobs report. With all major indexes (Dow Industrials, S&P; 500, Nasdaq, Wilshire 5000, Dow Transportation), including our own international Trend Tracking Index (TTI), now positioned below their long term trend lines, the question is whether the tide has turned on the markets.

While it’s still too early to tell, many signs are pointing in that direction. Before I jump on the bear band wagon, we need to get confirmation from our domestic TTI, which so far has remained in positive territory, but is showing signs of weakness.

To look at the big picture, I found this article, written last month titled “Stock market ‘winter’ is moving in.”

Here’s an excerpt with an opinion from Paul Desmond, who heads the demand-analysis firm Lowry’s Reports, based in Florida.

Desmond observes that bear markets have occurred over the past two centuries every 52 months or so, roughly every four and a half years. Although they seem like rare events, they’re actually as regular a part of the market cycle as winter is part of the seasonal cycle. Past market lows in just the past half-century include 1957, 1962, 1970, 1974, 1978, 1982, 1987, 1990, 1994, 1998 and 2002. Surely you recall at least a couple of those.

Desmond generally recommends moving portfolios to cash and selected shorts at the start of a bear phase, since virtually all groups of stocks tend to move down together at first, and waiting to see which groups of stocks emerge as countertrend heroes. In the early 1970s, the heroes were energy stocks, while in 2000-02 they were value and small-cap financial stocks. He guesses that energy, health care and utilities may buck the trend this time, but it’s too early to say with certainty.

I have to agree with Paul’s assessment, but I will let my Trend Tracking Indexes and momentum tables guide me as to the timing of either getting into or out of certain investments. I also believe that energy, health care and utilities have good upside potential and the momentum figures in our weekly StatSheet confirm this fact. This is why we own selected positions in all three of these areas.

As usual, I will implement our sell stop discipline should it turn out that we were too early, or simply wrong, with our investment decisions.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

The bears beat the bulls by a wide margin this week with all major indexes ending sharply lower.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has moved to +2.79% above its long-term trend line (red) as the chart below shows:

The international index dropped to -5.46% below its own trend line, keeping us in a sell mode for that arena.

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Reader Tom submitted the following chart which shows the economic output from all U.S. states compared to the rest of the world. While I can’t vouch for the accuracy it nevertheless still confirms that the U.S. is still the big dog on the block; it’s an interesting way to look at the globe (click on graph to enlarge):

“In the midst of a housing collapse and credit crunch, the impending doom of the U.S. economy is taken as gospel. But look behind the headlines, and the numbers tell a different story. The U.S. economy grew by 3.9% in the credit turmoil-ridden third quarter — following a 3.1% jump in the second quarter. That means that the United States added the equivalent of a new Saudi Arabia to its economy just since the beginning of April. And the fact that the World Economic Forum ranked the U.S. econom y the most competitive economy in the world last week got little press. And even when it did, the #1
ranking of the United States was explained away as a statistical
mirage.

This is not to say that the U.S. economy is in ship shape. But with all of the talk about China and India dominating our economic futures, it’s worth reminding ourselves where these new economic challengers stand in comparison to the United States today. Despite the high
economic growth rates of developing nations, the United States is by far the world’s wealthiest nation as measured by GDP — the broadest measure of economic wealth. And the rest of the world isn’t even close. This year, U.S. GDP is projected to be $13.22 trillion. That means that the U.S. economy is as large as the next four-largest economies in the world — Japan, Germany, China, and the United Kingdom — combined.

The map above — originally published here — puts the size of the United States’ global rivals in perspective. On the map, the name of each U.S. state is replaced by a country, whose GDP equals approximately that U.S. state’s GSP (gross state product.) A quick glance at the map leads to some fascinating — and unexpected comparisons.

Standing alone as a country, California would be the eighth-largest economy in the world and approximately the size of France. Texas’ economy is half the size of California’s and its GSP compares to that of Canada. Florida’s GSP is approximately the size of Asian tiger South Korea. Illinois’ economy is approximately the size of Mexico. Ohio’s economy is roughly the size of Australia’s. Tennessee’s GSP is the size of Saudi Arabia; Nevada, the size of Ireland; Alabama’s economy is the size of Iran. Bill Clinton’s home state of Arkansas, one of the poorest states in the United States, is approximately the size of Pakistan’s economy.

And what about the United States’ nearest rivals? Germany and China — #3 and #4 on the list of the world’s largest economies — are smaller than the economies of Texas and California combined. India’s $800 billion economy is on par with Florida. Brazil, as we see on the map, is comparable to New York. Russia’s economy is about the size of New Jersey (or Texas).”

Reader Nitin submitted an article from the NYT written by Floyd Norris titled “Credit Crisis? Just Wait for a Replay.” It tries to look beyond the Subprime debacle by trying to answer the question “What if it’s not just Subprime?”

It’s an interesting read and makes you look at other potential problem areas. This is not meant to dwell on negatives but to simply be realistic as to what else might be in store. To me, this view is more important for those who simply buy and hold their investments, and disregard any change in trends; because they will be exposed to an indefinable risk should the markets drift toward bear territory.

“As 2007 ends, it seems that the financial world shakes every time a company reveals some new exposure to the disastrous world of subprime mortgage lending.

But just how different was subprime lending from other lending in the days of easy money that prevailed until this summer? The smug confidence that nothing could go wrong, and that credit quality did not matter, could be seen in the many other markets as well.

That was particularly true in the corporate loan market. Loans were cheap, and anyone worried about losses could buy insurance for almost nothing. It was not an environment that encouraged careful lending.

“The severity of the subprime debacle may be only a prologue to the main act, a tragedy on the grand stage in the corporate credit markets,” Ted Seides, the director of investments at Protégé Partners, a hedge fund of funds, wrote in Economics & Portfolio Strategy.

“Over the past decade, the exponential growth of credit derivatives has created unprecedented amounts of financial leverage on corporate credit,” he added. “Similar to the growth of subprime mortgages, the rapid rise of credit products required ideal economic conditions and disconnected the assessors of risk from those bearing it.”

There are differences, of course, and they may be critical in averting a crisis. To start, there are virtually no defaults in corporate lending now, and even if Moody’s is accurate in its forecast that defaults will quadruple in 2008, the default rate on speculative loans and bonds would still be below the long-term average. That hardly sounds like a crisis.

And there is no reason to think that fraud was a big factor in the corporate loan market, as it seems to have been in subprime.

But the history of junk bonds provides a warning that defaults start to rise a few years after credit gets very easy. By that standard, says Martin Fridson of the research firm FridsonVision, a new wave of defaults is overdue. Already, even without defaults, he says, about a tenth of high-yield bonds are trading at distress levels — levels that provide yields of at least 10 percentage points more than Treasuries.

If a recession does occur, one can easily foresee a wave of defaults in junk bonds and their bank-loan cousins, leveraged loans. With highly leveraged structures supported by some of those loans, the surprises could be greater. It is sobering to realize that the issuing of leveraged loans set a record in 2007, even though the market contracted sharply late in the year.

If this was the year that many readers — not to mention financial reporters — learned what C.D.O., M.B.S. and SIV stood for, 2008 could be the year of C.D.S. and C.L.O. (For those who came in late, those abbreviations from 2007 are shorthand for collateralized debt obligations, mortgage-backed securities and structured investment vehicles. The new ones are credit default swaps and collateralized loan obligations — a special kind of C.D.O. backed by corporate loans.)

We have learned in the last month that credit insurers took big risks in backing C.D.O.’s and other exotic things. Some are scrambling to raise more capital to stay in business. One, ACA, may well go out of business.

But if the credit insurers turn out to have had inadequate reserves, what are we to make of the credit default swap market? Mr. Seides calls it “an insurance market with no loss reserves,” and points out that $45 trillion in such swaps are now outstanding. That is, he notes, almost five times the United States national debt.

Many of those swaps cancel each other out — or will if everyone meets their obligations. The big banks say they run balanced books, in which they sell insurance to one customer and buy insurance on the same borrower from another customer. But if some customers cannot pay what they owe, this could be another shock for bank investors. As it is, financial stocks have underperformed other stocks by record amounts this year.

One of the more remarkable facts about the subprime crisis is that total losses to the financial system may be about equal to the amount of subprime loans that were issued. On the face of it, that appears absurd, since many such loans will be paid off, and those that default will not be total losses. But, Mr. Seides said in an interview, “the financial leverage placed on the underlying assets was so high” that the losses multiplied, as the profits did when times were good.
“When there is more leverage” and things go wrong, he said, “there are more losses.”

The corporate credit market is vastly larger than the subprime market, and there are plenty of dubious loans outstanding that probably could not be refinanced in the current market. If some of those companies run into problems, defaults could soar and fears about C.L.O. valuations and C.D.S. defaults could spread long before there are large actual losses on loans.

There are other areas of potential weakness in 2008. Commercial real estate is one area where some see disaster looming. Others worry that some emerging markets could run into big problems because many borrowers there have taken out loans denominated in foreign currency and could be devastated if local currencies lose value.

It was the greatest credit party in history, made possible by a new financial architecture that moved much of the activities out of regulated institutions and into financial instruments that emphasized leverage over safety. The next year may be the one when we learn whether the subprime crisis was a relatively isolated problem in that system, or just the first indication of a systemic crisis.”