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“We are less bearish than a month ago. But to go overweight equities we would need to see genuine capitulation, value (i.e.1,200–1,220 S&P 500), ECB to cut rates or oil to fall to sub-US $110/bbl, Research Analyst Andrew Garthwaite, Credit Suisse, July, 2008.”

The good news this month is that the markets are oversold, cash levels are very high and financial and housing stocks are showing signs of life. Since early July, the defining scoreboard for capitulation looks like this: the S&P 500 Index has fallen as low as 1214, the price of oil has fallen to $133/bbl and the European Central Bank has been given more motivation to cut interest rates. Moreover, on average, US bear markets fall 28% over a period of 13 months, and as of this writing, the S&P 500 is already down over 24% peak- to-trough.

It has been a struggle for the Federal Reserve Board to restore consumer confidence. You know the bad news. Oil is driving inflation, even while pricing power and wage growth is anemic. There is no silver bullet to solve the current economic problem in the United States save a big decline in the price of oil. China is consuming more and more of this scarce resource, thus making strong Chinese growth bad for global equities. Energy-saving smart cars, low-cost wind energy, stabilized real estate prices and upbeat consumer confidence seem far far away, yet progress is being made.

Improvement is underway in the banking sector. US banks have recapitalized to the tune of $320 billion. Signs of financial stress are less acute than they were in January. San Francisco-based Wells Fargo, for example, just raised the dividend on its common stock. Retail sales appear to have stabilized over the past quarter, and the housing downturn is now more advanced, implying lower downside risk in the real estate markets. Moreover, given the magnitude of the housing bubble, the Fed is not expected to raise rates anytime soon.

As to the magnitude of the housing bubble, national numbers for new home sales are down 41% year-over-year. New home inventory came in at 453,000 units in May representing a 10.9-month supply on homes at the current sales pace. Rising foreclosures are weighing on the absolute level of existing home inventory. Meanwhile, existing home sales increased to 4.99 million units, up 2% over April numbers, but still down 16% year-over-year.

According to Credit Suisse research, the slowdown in housing has been underway since the summer of 2005. With interest rates edging higher, unemployment on the rise, stringent new mortgage underwriting in place and home prices declining, the number of purchase origination applications is expected to drop to levels not seen since 2000. Lending to private builders in this climate is winding down. While, difficult for developers, the deepening decline in new building permits is acting to work off the excess housing supply. Based upon the national supply-demand analysis, “we believe the sharply lower construction activity we’ve seen (and even further declines from current depressed levels) will help reach a peak in housing inventory in spring ’09…,”(D. Oppenheim, Credit Suisse, July 17, 2008.) The peak tends to signal the beginning of a gradual return to price stability. This potential forthcoming inflection point for homebuilding stocks is worth monitoring.

With so much apparent bad news, you may be asking yourself, “what real hope is there here for the short term future of US equities?” In fact, research analysts are now moving money back into the United States for the first time in a decade. The dollar is cheap, US corporations have been quick to cut costs in response to a weaker global outlook and monetary conditions in the US are the easiest in 20 years. You can thank Congress, The Executive Branch of the government, the Fed and the SEC, for their quick policy response to current economic problems. In fact, in terms of economic momentum, relative to other world regions, as Figure 2 below illustrates, the US is now the best world market when accounting for economic momentum, earnings momentum, macro-factors, monetary conditions, valuation and risk. The United Kingdom and continental Europe have the worst score, and emerging markets are slightly worse than before.

Institutional investors are beginning to overweight US stocks, because the dollar is cheap and in a bottoming process. Analysts report that the pound sterling and euro are trading 28% and 35% above fair value. With some 20% of total US mutual fund ownership now in overseas assets, as the dollar rallies in the future, much of this money will return home. Add to this the reengagement of cash on the sidelines, and the US market has significant upside potential over the next few years.

Contact us to learn more about working with Vaughn Woods Financial Group.

Best Regards,

Vaughn L. Woods, CFP®, M.B.A.

*Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views off Delta Equity Services Corp. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0012

**Marketedge.com, Pershing NetExchange Pro, Bloomberg, Credit Suisse