And, as I reported in The Weekly Commentary weekly during each of the past nine weeks, a continued crisis in confidence will probably result in further economic slowdown, and maybe a full-fledged recession. I believe the probability of a recession has grown dramatically – it has increased to approx 50% in my opinion. Many economists agree with this forecast.

The stock markets have already dropped in anticipation of the economic slowdown. There is a possibility the forecasted downturn is now fully factored into stock prices. If true, this would not be the time to sell. On the other hand, the economic downturn could be long-lasting and severe. It is very difficult to predict its severity. There is no exact, 100% sure-fire way to time recessions or markets. Due to the lack of clarity in my crystal ball, I recommend the following, depending upon which category fits your unique circumstance:

1. Aggressive investors, moderately aggressive investors, and investors who do not intend to touch their investments for 10 years or longer – continue to hold the current allocation of core investments, and wait to gather more information, and carefully watch central bank activities especially from FED Chairman Bernanke later this week.

2. Investors who need to withdraw from the investment portfolio – “park” any amounts you expect to withdraw within the next 5 years in a short/intermediate term bond fund.

3. Conservative, moderately conservative, preservation minded investors and investors who with start withdrawing from their portfolio in 5 to 10 years– reduce exposure of the more volatile stock and stock mutual fund holdings in your portfolio.

“If things go wrong, don’t go with them.”

– Roger Babson

This weekend I travelled to Washington DC and back on the Amtrak train. Both trips were great. On time, stress free and without the traffic mess on Rt 95. I enjoy DC, especially the museums. I spent the entire day Saturday riding the Metro and roaming the Smithsonian while my wife Jo Anne and my daughter Jennifer shopped. One display in particular struck me: The Wright Brothers’ plane – yes, the original Wright Brothers plane – is there. But, it was their story that left an indelible impression. They were bicycle makers, not engineers or scientists. The Wright Brothers simply had an incredible desire to achieve. At the time of their inventions, aeronautics was in its infancy. The Wrights were forced to get basic aerodynamic data from a German who was acknowledged as the worldwide expert. His data was wildly incorrect. So, the Wright Brothers did what you expect any American to do – they improvised and innovated – they built a wind tunnel and compiled their own aerodynamic data. And, their efforts resulted in the first, heavier than air, controlled flight. All of this – WITHOUT – government grants.

Last week the number of NEGATIVE developments outnumbered POSITIVE developments. But, the stock markets still moved higher.

Positives:
1) Markets hang in on belief EU officials will come to some sort of an agreement to force Greek bondholders to mark to reality, provide some debt relief to Greece and buy time and refinancing backstop for Italy and Spain
2) Initial Claims, while higher than expected, has 4 week avg at lowest since April
3) Philly mfr’g surprises to upside at +8.7 vs est of -9.4 and -17.5 in Sept
4) Multi-family starts a bright spot for construction industry, reach highest since Oct ’08
5) NAHB home builder survey rises 4 pts to best since May ’10 at 18

Negatives:
1) CPI in Canada 3.2% y/o/y, CPI in Hong Kong 5.8%, CPI in Malaysia 3.4%, CPI in the US 3.9% and last week saw euro zone CPI at 3%. Inflation is a growing problem
2) Months supply of existing homes ticks up to 8.5 from 8.4
3) Operation Twist this: refi’s fall 16.6% and purchases drop 8.8%
4) NY mfr’g at -8.5 vs expectations of -4.0
5) German IFO business confidence lowest since June ’10, French business confidence weakest since July ’10
6) Moody’s downgrades Spain’s credit rating to one notch below S&P and Fitch
7) China’s Q3 GDP rises 9.1%, touch below estimates and Shanghai index down 4 straight days to lowest since Mar ’09 (Source: The Big Picture).

Yes. But, there are many danger signals, too. At least, that is what one highly respected expert – John P. Hussman PhD of the Hussman Funds – says in his periodic newsletters. Hussman is a name many have heard before.  John P. Hussman PhD is a highly respected financial expert who has a straightforward and direct opinion of whether the US is headed into a recession. Here is an excerpt from a recent article (the link to the entire article is: www.hussman.net/wmc/wmc111017.htm ):

“From my perspective, Wall Street’s “relief” about the economy, and its willingness to set aside recession concerns, is a mistake born of confusion between leading indicators and lagging ones. Leading evidence is not only clear, but on a statistical basis is essentially certain that the U.S. economy, and indeed, the global economy, faces an oncoming recession. As Lakshman Achuthan notes on the basis of ECRI’s own (and historically reliable) set of indicators, “We’ve entered a vicious cycle, and it’s too late: a recession can’t be averted.” Likewise, lagging evidence is largely clear that the economy was not yet in a recession as of, say, August or September. The error that investors are inviting here is to treat lagging indicators as if they are leading ones.

The simple fact is that the measures that we use to identify recession risk tend to operate with a lead of a few months. Those few months are often critical, in the sense that the markets can often suffer deep and abrupt losses before coincident and lagging evidence demonstrates actual economic weakness. As a result, there is sometimes a “denial” phase between the point where the leading evidence locks onto a recession track, and the point where the coincident evidence confirms it. We saw exactly that sort of pattern prior to the last recession. While the recession evidence was in by November 2007, the economy enjoyed two additional months of payroll job growth, and new claims for unemployment trended higher in a choppy and indecisive way until well into 2008. Even after Bear Stearns failed in March 2008, the market briefly staged a rally that put it within about 10% of its bull market high. “

Good news is good and bad news is bad, but a lack of bad news can be good, at least for investors. Stocks rose about 1% last week on improved trading volume, as third-quarter earnings reports—with the exception of Apple’s (ticker: AAPL)—came in generally as expected.

There was also a lack of bad European news and “this is a headline-driven market,” notes Andre J. Bakhos, director of Market Analytics for Lek Securities. Other than that, it has been a pretty theme-less market, he adds.

Last week marked a third consecutive week of gains, as the Dow Jones Industrial Average rose 1.4% to finish at 11,808.79. The Standard & Poor’s 500 Index picked up 1.1% to 1238.25. But the Nasdaq Composite bucked the trend, falling 1% to 2637.46.

Many investors intuitively know that stock movements among S&P 500 companies have been highly correlated of late, so much so that fundamental stock picking seems to have been hijacked by one big macroeconomic worry, that of a European banking crisis.

The other big macro worry, notes one CIO, has been a potential U.S. recession, but here again, while the macroeconomic news hasn’t been great, a lack of bad news has helped investor sentiment. “Can Europe ring-fence the problem banks? Maybe things look better than they did two weeks ago, but we are not out of the woods yet,” the CIO says.
 
Many look to a European summit to be held over the weekend, but already it seems that another meeting Wednesday will be even more important. “I’ve lost track of how many European meetings there have been,” Bahkos says.

Anyone who believes there will be a clean and definitive answer on Europe’s sovereign-debt problem is going to be disappointed for many months. For now, at least, it seems like the “risk on” trade is back, but European leaders have had a nasty habit of disappointing markets on Mondays.

The correlation within the equity market has never been higher, according to Bespoke Investment Group. When the S&P 500 advance/decline line (advancing stocks minus decliners) reaches plus- or minus-400 in a session, Bespoke calls that an all-or-nothing day. Since the end of July there have been 31 all-or-nothing days, more than the total for the 1990s. This year will top 2008 for such volatile trading days, according to Bespoke.

The volatility most likely is due in large part to high-frequency trading and investors’ heavy use in recent years of exchange-traded funds, which must rebalance their portfolios every day.

As noted, Apple fell sharply last week on disappointing earnings, but McDonald’s (MCD) reported strong third-quarter earnings Friday, which drove the stock to an all-time high of $92.32. Mickey D’s stock has been the best Dow performer by far since hitting lows in 2003 (Source: Barrons Online).

Last week, in an unusual occurrence, U.S. Stocks, Foreign Stocks and Bonds increased. During the last 12 months, BONDS outperformed STOCKS.

Returns through 10-21-2011	1-week	Y-T-D	1-Year	3-Years	5-Years	10-Years
Bonds- BarCap  Aggregate Index	.3	6.1	4.3	8.0	6.5	5.6
US Stocks-Standard & Poor’s 500	1.1	.1	1.9	5.1	-5.1	1.2
Foreign Stocks- MS EAFE Developed Countries	.4	-11.3	-10.0	4.1	-5.4	2.9

Source: Morningstar Workstation. Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  Three, five and ten year returns are annualized excluding dividends.