The price-to-peak earnings multiple stands at 12.2x as of the close of the holiday-shortened trading week.  The S&P 500 index was little changed as a sell-off on Friday gave back all of the gains from earlier in the week.  The market dropped as a result of a debt crisis in Dubai where Dubai World pleaded for a for six month reprieve from its debt obligations.  Dubai has built some of the world's most expensive and exotic real estate over the last decade, largely with debit financing.  The trouble at Dubai World reignited concerns about default risks which could further mar the already-fragile balance sheets of the global banking system.  Dubai's government stepped in to guarantee Dubai World's debt in order to stave off a run on banks, but the sheer size and scope of this debt is beyond the ability of Dubai alone to rectify.  It is likely that other gulf Emirates such as Abu Dhabi will have to play a role in heading off a unprecedented default which would hit already-weak European (especially British) banks especially hard.

The trouble in Dubai caused the dollar to gain strength over the last few days in a flight to quality.  This event could cause stock investors to reassess their risk tolerance for the balance of the year.  Global uncertainty generally boosts the dollar, but this would not necessarily be good for U.S. equity markets.  Over the past few weeks, U.S. stocks have benefited from the dollar's decline, as investors believed that currency weakness makes U.S. goods and services more affordable in foreign markets.  If this Dubai development and its repercussions reverse the downward trend in the dollar, this would put additional strain on an equity market that is somewhat over-valued to begin with.

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The percentage of NYSE stocks selling above their 30-week moving average dropped to 78%.  As we expected, this investor sentiment indicator has begun to slowly normalize as fewer stocks are now trading above their moving average.  In general, we consider the current level elevated but no longer at the extreme bullishness of last summer and early fall.  The AAII sentiment survey shows that the number of bearish investors now equals that of bullish investors, with both at 41.7% .  However, the trend is clearly bearish as the percentage of bearish investors rose by 10% while the bulls dropped slightly.  Keep in mind, these are only two metrics that we observe in order to get a reading on sentiment and no metric can...

measure investor psychology perfectly.  That being said, with only a month left in the calendar year, we would not be the least bit surprised to see a stock sell-off in December as investors lock-in profits before the close of the year.

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The U.S. equity market has been roughly flat for the last six weeks with the S&P 500 trading right around 1090 - 1100.  The near-term direction of the stock market is highly unpredictable and we could easily see it going in either direction.  That being said,  any successful long-term investment strategy requires the proper balancing of risk and reward in one's portfolio.  We never claim to be able to forecast the future, but it appears to us that this is a time when the market risks outweigh rewards.  Equities are sitting atop an extended rally that is based on shaky fundamentals and wildly optimistic forecasts of future growth.  We believe that any disappointments in the pace or scope of economic recovery (particularly as the government stimulus begins to taper off) could be met with a recalibration of expectations.  While we believe it is advisable to remain net long equities, a more defensive stance is certainly justified.