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To: ild who wrote (198001)	10/16/2002 8:02:31 PM
From: ild	Respond to of 436258

Wednesday Morning October 16, 2002 : Special Hotline Update The Market Climate remains on a Warning condition for stocks (unfavorable valuations, unfavorable trend uniformity). In bonds, the Market Climate is characterized by unfavorable valuations and favorable trend uniformity. As I've noted before, favorable trend uniformity in bonds is not nearly as positive as it is for stocks, but current conditions warrant a modest exposure to intermediate Treasury maturities of about 7 years, with the majority of fixed-income investments allocated to very short-term maturities. Corporate and mortgage backed bonds remain a minefield. I don't believe that the credit problems of recent years have nearly washed out. The terrible continuing action in risk spreads is one of the main factors that favor intermediate-term Treasuries here. The deleveraging cycle that follows a credit bubble takes a very long time to run its course, and this one is just getting warmed up. Tuesday's stock market rally gave us a number of great opportunities to manage our equity positions, while the plunge in long-term bonds created a nice opportunity to slightly increase our position in intermediate Treasury maturities. Our objective is to align our position with the prevailing Market Climate, while taking day-to-day opportunities to purchase higher ranked candidates on short-term weakness and to sell lower ranked holdings on short-term strength. So while Tuesday was nothing special in terms of our one-day returns, it was the kind of day that often makes a significant difference in our returns over time. In everything, the key to success is to find a set of daily actions that you're confident will produce good results if you follow them consistently, and then follow them consistently. As for quality, Tuesday's rally was not impressive from the standpoint of volume, and despite relatively good breadth, the ratio of advancing issues to declining issues fell short of what would be expected from a rally of this size. Also, utility stocks were weak. While one might think this is reasonable given the terrible action in bonds, it is actually inconsistent, and an important divergence in my view. From recent action, it is clear that the weakness in utilities is driven neither by interest rate action or beliefs about economic prospects. This leaves concerns about energy prices and credit risk as the primary signals being conveyed by utilities here. Though we do hold positions in a few select utilities, the majority of utility stocks continue to display poor market action on the measures that we emphasize. As I note in the latest issue of Research and Insight, the market's enthusiasm about bank earnings (which largely drove Tuesday's rally) is misplaced. These earnings are a result of unusually wide net interest margins thanks to a steep yield curve. This is not a robust source of long-term stability in bank earnings. After the close, Intel warned that it saw no improvement in technology prospects, prompting a sharp sell-off in after hours trade. We'll see whether that follows through in Wednesday's trading. At this point, the market has finally worked off its deeply oversold condition from the relentless declines of recent weeks. That does not mean that stocks will or must decline here, but the intense compression behind the recent market surge has now been relieved. I have absolutely no forecast about short-term market action here. The fact that stocks are no longer oversold invites the possibility of renewed weakness, but there is no reason why the market could not drift higher instead. Our fully hedged position is not driven by a "bearish" outlook, but by a Market Climate that has not historically rewarded market risk. We aren't speculating on a market decline (in fact, we never take net short positions), nor should our position be interpreted as a forecast. We are simply attempting to remove the impact of market fluctuations from our portfolio, because we don't have sufficient evidence that market risk is worth taking. For now, we're fully hedged in stocks, and generally defensive with regard to bonds, though with a modest exposure to intermediate maturity Treasuries. hussman.com