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

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

The Fed’s ¼% lowering of the interest rate, along with worldwide coordinated efforts to provide liquidity to “needy” banks, had the bulls on the run and the bears took over.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has moved to +3.79% above its long-term trend line (red) as the chart below shows:

The international index dropped to -2.12% 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.

Lack of confidence has played a big role in the markets lately. When banks don’t want to lend to each other then fear has to be stronger than greed.

Tuesday’s 300 point drop in the Dow was based on disappointment that the Fed lowered rates only by ¼%. Wednesday, the markets (Dow) rallied some 272 points right out of the gate after the Fed’s plan of adding liquidity to credit markets received a warm welcome. However, enthusiasm faded fast as the markets dropped into negative territory by 111 points at its trough. That’s a huge range and shows utter confusion in the trading community. The reason: Lack of confidence in the Fed’s ability to deal with the crisis at hand. Only last minute upside activity pushed the major indexes into positive territory for the day.

I was reminded of that when I read MarketWatch’s feature story titled “Falling into the liquidity trap,” by economist Dr. Irwin Kellner. I have referenced his articles before, and I like his no-nonsense approach to analyzing economic events. Short, sweet and to the point.

He writes that “today there are some similarities to the liquidity trap of the 1930s. The credit crunch is clearly one of them. No matter what the Fed does on Tuesday, it will not be able to thaw out the frosty financial markets.

This is because the markets lack confidence. As I wrote two weeks ago, “fear, and not a lack of liquidity, is what’s freezing up the credit markets … and … it’s going to take a lot more than infusions of liquidity to thaw them.”

While I agree with his assessment, I am also aware that his article, and many others I have pointed to in various posts, do not give you any idea about market direction. It’s simply an unknown and the only way to make reasonable investment decisions is to follow the major trend. Markets will react to fundamental economic changes or crises in any way they see fit, but you can be certain that prices of underlying securities will reflect any change in sentiment, either to the upside or to the downside.

That change we can measure via our Trend Tacking Indexes, which only have one function: To keep us on the right side of the market.

The Fed did the expected yesterday by lowering interest rates ¼%. For Wall Street, it turned out to be a disappointment since false hope of a ½% cut was not met. The reaction was fast and furious, and all major indexes retreated sharply with the Dow dropping some 300 points.

It will be interesting to see if this pullback was a one-day event and if the markets can resume their upward path again, which they started the beginning of December. Here’s what I can’t figure out. The markets are usually in an anticipatory mode by focusing on possible events some 6 months in the future. The worsening housing market and credit crisis would certainly qualify as an event that can have some dire impact, yet Wall Street seems to completely ignore the implications. Maybe the old saying about climbing a wall of worry has something to do with that…

In the meantime, the major trend continues to be murky and more time is needed to sort out where we’re going. Our Trend Tracking Indexes (TTIs) are offering a mixed picture with the domestic one still sitting above its long-term trend line and the international one still in sell mode:

Domestic TTI: +5.19%
International TTI: -0.61%

Below please find the link to the most recent ETF Master list, which has been updated with yesterday’s closing prices. This will enable you to work with more recent data. You can download the file at:

http://www.successful-investment.com/SSTables/ETFMaster121107.pdf

The Washington Post featured an interesting article by Steve Perlstein called “It’s Not 1929, but It’s the Biggest Mess Since.” It’s another well written review of the Subprime/credit crises, which contained some nuggets of knowledge I was not aware of. It’s classic Wall Street and shows you how to squeeze more value out of an investment.

It starts with mortgage-backed Collateralized Debt Obligations (CDOs). Here’s how Steve describes it:

By now, almost everyone knows that most mortgages are no longer held by banks until they are paid off: They are packaged with other mortgages and sold to investors much like a bond.

In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next.

With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches — those with the lowest credit ratings — were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the “mezzanine” tranches, which offered middling yields for supposedly moderate risks.

Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same “tranching” process, they could use these mezzanine-rated assets to create a new set of securities — some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired.

You may have to read that last paragraph twice to get it. The middle or “mezzanine” tranches, which were originally not rated AAA, were sliced up again into 3 sections, which now suddenly included again AAA-rated securities. In other words, AAA quality was created out of thin air.

Ingenious, but I have no clue how ratings agencies can go along with this kind of scheme. It simply tells me that ratings on any security nowadays may not have the true value you think it does. While you and I may not be buying tranches in CDOs, it still makes me wonder if ratings agencies have any integrity left.

Lax lending standards were one of the prime causes of the Subprime debacle. One of the terms you most likely have heard is that many real estate buyers qualified based on “stated income.” What that means is that you can write down your income based on what you need it to be to qualify and not what it actually is—without verification. Where I come from, we call that fraud.

I was reminded of that when I read Bill Fleckenstein’s article “Home-loan house of cards ready to fall,” in which he mentions some examples of what borrowers went through to qualify for a home loan. Those efforts ranged from the above “stated income” to physically copying and pasting bank statements to elevate homeownership-at-all-costs to a new level. The unknown here is how widespread this practice was during the lending heydays; although my guess is that it was the rule and not the exception.

I agree with Bill’s assessment that the Subprime mess will pass through various stages with the damage lasting for years. The interesting part of his story is that he posted it on 1/15/07, some eleven months ago!

His observations are right on, and I especially agree with his thought to “not take your eye of Subprime for a second,” which is why I have harped on it for most of this year. It will change the investment landscape for years to come and, being aware of these potential problems is the first step to preserving your portfolio when the markets finally realize the true implications.

The Southern California area I live in is a hotbed of overleveraged real estate, leased automobiles and high-end lifestyles that for many have been financed via the housing ATM over the last few years. Sure, there are truly wealthy people who can easily afford that $3 million dollar home, but the masses made the switch to the fast lane lifestyle via easily available credit. The words moderation and frugality are not known here.

While this attempt of keeping up with the Joneses is slowly coming to an end with real estate values plummeting, reality has really not sunk in yet. Why is it that many have the uncontrollable desire to show off or at least give the impression of keeping up with the neighbors?

Shira Boss’s book “Green with Envy” tries to shed some light on this question and presents a whole new way to look at financial (un) happiness. It’s a fun read since the author looks into the lives and checkbooks of our neighbors and presents the shocking gap between public image and what’s really going on behind closed doors. The book features 4 scenarios:

1. The young couple next door. The pay cash for their apartment and go on shopping sprees. You wonder how they can afford it.

4. The baby boomer at fifty. He’s got kids in college and no retirement fund—and the clock is ticking.

It’s a compelling tell-all about what’s going on with other people, while presenting a new perspective on financial well being. I found it extremely timely given the fact that real estate is now in a prolonged slump, reducing wealth and causing many with big, inflated egos to face reality sooner or later.