Reprinted Letter To Clients.

From a letter sent to clients 2/28/07.

I felt that I would speak a little on yesterday's market action. Since the market had gone something like 25 months without at least a 2% daily correction in the S&P 500, it was inevitable that the streak would eventually end. The sudden downturn in the afternoon has been attributed to a technical glitch in electronic trading. For now I will accept that explanation. For perspective yesterday's action represented about a 3%-4% decline in the various major indicies. This basically puts the markets back to levels where they traded in early November. Cash in client accounts as well as our use of ETF's likely lessened this impact in accounts.

Market pundets are speaking to various reasons for the action yesterday besides the technical concerns. Some are blaming this on Monday's decline in Chinese stocks, others blame comments attributed to Former Fed Chairman Alan Greenspan. An implosion in subprime lending and the possibility of tightening credit for financial assets gets it's share of the blame and there are the inevitable worries from some quarters about a slowing economy which also usually brings out all of the market naysayers.

All of these reasons likely has some validity yet I think most miss a few basic points. 1st is that the market according to our own proprietary analysis has been very overbought for a long period of time. Stocks have risen in a virtual straight line since making their lows last summer. Markets that become overbought usually lead to higher levels of speculative activity and higher levels of complacency among investors. We have seen this recently as margin debt has risen to record highs, cash levels at mutual funds is at record lows while money inflows into mutual funds from investors has hit new highs. This situation was ripe for some type of pullback. In fact yesterday's action (but perhaps not it's intensity) is not uncommon when markets have advanced for long periods of time as we have done in the last 8 months. In retrospect perhaps we should be more surprised that it took so long to have any real pullback.

Markets will do what they have to do to prove the most amount of people wrong which is a simple way to state that it's the nature of markets to do things that assure a high level of discomfort for most investors. Markets are profitable because at their core they are so frustrating. If they were predictable and easy, we couldn't make so much money trading them.

What I believe is a better point of concentration is whether yesterday's large drop might be signaling that a significant change in market character is about to take place. For months the market has been chugging along steadily, with buyers stepping up every time that we pulled back and it will be important to see how buyers react over the next several days. As I'm writing this, stocks have staged somewhat of a recovery this morning after some back and forth at the open. However, every major market index suffered major distribution yesterday. Thus the reaction of traders and investors will key us into whether yesterday marked a change in market trend or presented a buying opportunity in a roaring bull market.

More aggressive short-term traders are going to look for a bounce in the next few days, which isn't an unrealistic expectation given the intensity of yesterday's losses. But for the longer-term investor, the focus now turns to what happens on a bounce. The true character of this market will be fully revealed on the second and third tries at a recovery. If those attempts are turned back, we will know that things have changed and that we are likely to see a downtrend that persists for a while. Many investors, trapped by yesterday's collapse in prices will probably be looking for exit points. They suffered some psychological as well as financial damage and they would prefer safety and security. It is also important to note that stocks are still overbought and we are closing in on the April-October period where stocks have historically been weak. Thus a correction in prices in the 5-10% range occurring between now and the fall is something that we must factor into our investment equation as a possibility at this time.

However, I want to stress that while I think there is is a possibility of a longer and deeper price correction, it remains at this point simply a possibility. What is important is that yesterday's action threw up a yellow flag of caution into the investment equation. We are on notice that the character of the markets might be changing and we may need to put a more cautious investment stance out for certain client accounts. In short we may need to bring the defensive team out on the field soon. What is important though is that we have a plan for situations such as these. Plans can never eleminate completely all possibility of loss but they are designed to mitigate the effects of larger price declines on client accounts. We will monitor this situation and adjust investment accounts accordingly as the situation progresses.