Six months into 2008, the Dow Jones Industrial Average is down 14.5% and has fallen 19.9% from its recent high recorded in October 2007. A drop of 20% or more from a peak is generally considered a bear market. The NASDAQ Composite, a tech-heavy index, is also off approximately 13% this year, and even the smaller cap issues, as represented by the Russell 2000, is down nearly 10% this year. As we have previously pointed out, until the financial sector of the market comes back from its well-earned destruction, the overall market will continue to trade within a range at best. There is no reason, in our opinion, to believe that we have seen the end of these troubled times, and we recommend remaining cautious and ultra-conservative within the market.

Few would argue that the Federal Reserve has been nothing but accommodative to the stock markets, economy and credit markets with low interest rates and other creative strategies. We would argue, too much so. It would have been difficult to have ignored all of the commentary regarding the serious issues facing America and, in turn, the world over the past several months, so we will only list a few of the market headwinds that currently exist: historically high oil prices in the U.S.; the housing collapse; the continued decline in the exchange value of the dollar vis-à-vis major foreign currencies; rapidly rising headline inflation; and a downward re-evaluation of forward earnings on Wall Street. We would like to tell you that these issues are of diminishing concern as we look to the back half of 2008, but we do not believe this to be true.

In trying to make sense of why we are where we are, one needs to take into account the developments that have led up to the current economic and financial crises. One of the most significant financial innovations over the past two decades has been the unabated “securitization of debt.” Although not an entirely new concept, the mass scale of this financial creation has made an enormous impact on just about every sector of our economy and our lives. In essence, the securitization of debt has allowed consumers to maintain a standard of living far beyond their incomes, which have, on average, dropped in real terms over the same two decades. As a recent article in the Financial Times correctly points out, in our opinion, “financial innovation has been responsible for reducing the direct relationship between consumption and income.” It has, simply put, been that we have lived with Illusions of Prosperity – a worthwhile read, authored by A. U. Freemarket.

We can debate about what was the “last straw that broke the camels’ back” but the current economic and financial crisis has been developing for years and will not be corrected overnight. The Federal Reserve’s effort to artificially prop up normal economic cycles and cushion the effects of a bursting bubble is only to prolong the inevitable. Regardless of government-manipulated statistics, for all intent and purposes, we are in Recession of which the depth will not be quickly learned.