The dollar reaches new lows. The housing market shows no sign of a bottom. Oil almost touches $84 before backing off. Interest rates go up after the Fed cuts. So naturally the stock market keeps climbing. But then, consumer spending came in strong, employment looks like it may be ok, inflation (at least by one measure) came in below 2%. This week we look at the question of whether you could have a continued bull market and a recession. (Maybe.) We look at the bigger picture for the dollar and interest rates and examine the ugly data from the housing sector. Inflation or deflation?

But before we get started into what should be an interesting letter, let me thank those who completed my reader survey last week. Over a thousand of you gave specific comments and I looked at every one. If you didn't take the anonymous survey yet, but would like to, just click this link. All I really know about 99.9% of my readers is an email address. The survey is just a few questions which gives me an idea of the audience I am writing to and some feedback on how I'm doing. And feel free to make comments at the end in the space provided.

As my gift to you for taking the time, when you finish the survey you will be given a link to the audio of a speech by Dr. Mike Roizen, the author of You, The Owner's Manual and a dozen other blockbuster best-sellers. He spoke at my Strategic Investment Conference this spring (co-hosted by Altegris Investments) on "How to Stay Young - Getting Your Body to Give You a Do-over." (If you can't listen when you finish the survey, save the link.) Thanks.

"Of his bones are coral made:
Those are pearls that were his eyes:
Nothing of him that doth fade,
But doth suffer a sea change
Into something rich and strange"
(The Tempest - Shakespeare)

The term "sea change" has come to mean a profound transformation ever since Will Shakespeare used it in The Tempest. I think this week we witnessed a true sea change in central bank policy, on both sides of the Atlantic. The stock market rejoiced over a 50 basis point cut from the Fed, assuming that it will stimulate growth and avoid anything more than a slowdown. In this week's letter, we ponder several questions. Why did the Fed decide to cut now when the rhetoric of just a few weeks ago was that of inflation fighting? What do they see? Are more rate cuts coming? Will they make any difference? And who is Frederic (Rick) Mishkin and why is he maybe the most important Fed governor you haven't heard of? There's a lot of ground to cover, and it should make for an interesting letter.

But first, I need to acknowledge an anniversary of sorts. Some seven years ago I put this e-letter on the internet, with (maybe) 2,000 names to send it to. Today, it goes out every week to more than 1,000,000 readers and is posted on scores of web sites and blogs. I have to confess with being a little (well, a lot) amazed by it all. It has changed my business practice in ways that I could not imagine seven years ago, and all for the better. Someone asked me what I will do when I retire. I told them I would read, write, travel and speak, which is pretty much what I do now, along with a few extra duties here and there.

But it is a great life and I want to thank you for allowing me to come into your home or office, and for recommending this letter to friends, which is the way the readership has grown. And because I want to keep writing for a long time and I want to keep you as a reader, I am going to make available to you a speech on how we can all live longer by Dr. Mike Roizen, who wrote You - The Owner's Manual (and You - On a Diet , and the other monster best-sellers in the series). He also appears on Oprah about six times a year. I am lucky enough to call him both friend and my doctor.

Summer driving season is almost upon us. I remember more than a few long road trips with young kids, who would eventually get bored and tired and lulled into sleep, and with a stop for gas would wake up and ask, "Are we there yet?" or "Where are we?" They would be impatient to get "there" (ok, so was Dad), and the journey was something to be endured rather than enjoyed for its own sake. Today, traveling with the older kids (6 of them 18-30, with just one still at 13) is a lot different, as we look forward to the time together, with great conversation and lots of laughs.

I bring that up as a way to introduce this week's letter. I have been suggesting since last fall that the potential for a recession/serious slowdown was quite high, brought on primarily by weakness in the housing market. Today we look at why I still hold that view, as the data shows a slow leak of the housing bubble and consumer spending starting to slow as inflation eats into buying power, even though some data shows that some parts of the economy are still strong. Unlike Bernanke, who this week said that the problems in the subprime markets will not spill over into the economy, I expect the subprime mortgage predicament to infect the whole housing market and create a drag on the whole economy. Depending on what you want to hear, you can decide that this week's inflation data was positive or a problem, that housing is rebounding or going further into recession, and that consumer spending is starting to rise or fall. Bulls see it one way and bears another.

Clearly, from a stock market point of view, there is nothing to be worried about. What slowdown? Recession? I spit on your recession! Like a kid in the middle of a long road trip, it is hard to be patient. There has never been a recession without an accompanying serious bear market. It is tough to be sanguine about the near-term prospects for the stock market if you see a recession in the future. Stock market investors clearly must believe either that there will not be a recession or that for the first time the market will continue to rise. Waiting for that correction brings back memories of the impatient question "Are we there yet?"

Clowns to the left of me,
Jokers to the right, here I am
Stuck in the middle with you!
- Stealers Wheel, 1974

The recent data on the economy is stronger than was expected. Does this mean that the slowdown we have seen for the past few quarters is behind us? Other data suggests the economy is weakening (witness the very slow 1.3% GDP growth last quarter). This week we look at the seeming disconnect in the data, briefly examine where the real stock market booms are happening, and re-visit the housing markets. It's a lot for what will be a quick letter (and lots of charts), as I am trying to leave town, so let's jump right in.

(And yes, I was supposed to finish a letter I started two weeks ago on black swans, but a technicality is holding up that letter. It will be resolved next week.)

What are the odds of a recession? According to a recent Fed study, they may be 51.9%. Close enough to 50-50 for government work. We analyze this study, look at a few graphs which show a major disconnect between the housing market and the US manufacturing and services sectors, and then close with some comments on yet another proposed rule change. But let's start with a few housekeeping items.

The latter half of this letter will be written primarily to my colleagues in the financial services area, and to managers, entrepreneurs, and businesses who anticipate the need to raise capital in the future. There are some proposed rule changes at the NASD that will significantly limit the ability of a registered representative to communicate with clients about private offerings, ETFs, venture capital, DPPs, and other offerings. In some cases, it will effectively prohibit communication on the items. This is not just about hedge funds. I think these rule interpretations will have the unintended consequence of the potential to severely impact capital formation in this country. This is under the radar screen of 99% of my colleagues.

Many of my US clients and prospects wonder why I do not write to them about my opinions on the hedge funds and private offerings that are offered to them. The simple fact is that the NASD asserts (if you ask, which I did) that even a simple letter, properly disclosing my income relationship with the offerings, would be considered a research report and therefore fall under the research analyst rules. In fact, any marketing material would is in effect considered research, and thus cannot be sent by a registered representative to clients. The NASD has not publicized this interpretation, but they are getting ready to assert it in proposed rule changes. If you are in the industry, I urge you to read the latter half of this letter and make your feelings known.

How has another year come and gone so quickly? It seems like someone hit the fast forward button. And once again, all too soon, it is time for me to demonstrate my masochistic nature and write a forecast issue. Rather than going into details on every topic, I will try and stick to the big picture and leave the fine points for later letters.

Each year as I do this forecast, I look for a theme. What will be the driving factor which will set the stage for the economy? In 2001 it was the coming recession; in 2002 it was a weak recovery and the beginning of the Muddle Through Economy; in 2003 it was Surprise and Transition. In 2004 it was the Silver Lining Economy; in 2005 it was the See-Saw Economy. Last year it was The Gripping Hand, as Bernanke had the economy in his interest rate gripping hand. Who knew in January 2006 how far he would go? For masochists, you can go the archives at www.2000wave.com and read those forecasts.

This year the theme is The Goldilocks Recession. As outlined in the past few months, I think the US will have a mild recession or slowdown in 2007. That premise leads to a lot of other follow-on forecasts. Why the theme? Remember that after finding things were just right, Goldilocks ended running out of the house when the bears came home. And I think the housing bear will finally come home in 2007.

One of my favorite cartoons of all time is that of a very scrawny mouse caught out in an open field with a rather large hawk swooping down on it. There is no place to run, no place to hide. All the mouse can do is face the hawk and give him the bird, so to speak. The caption runs something like, "In the face of total disaster the only appropriate response is utter defiance."

And while the economic data is not a total disaster, it has not been good this week. Yet the response of investors everywhere is defiance, or at the very least serious nonchalance.

Recession possibilities? "What recession? I spit on your talk of recession." They continue to assume that things will turn out much better than merely OK. All manner of investments are priced for perfection, perfection being defined as growth slowing enough to take out inflation risk yet not enough to hurt the ever upward rise of corporate profits. Goldilocks is the name of the game.

Yesterday the Philadelphia Fed Business Economic Survey came in at the lowest level since the recession in 2001. Some argue that it is just one month's worth of data, and "...besides, it is Philadelphia. Those numbers are always quirky." And why pay attention to the Conference Board's Index of Leading Economic Indicators? The bond market has its own opinions, and they are different than that of the stock market. With all of this as backdrop, we will then think about why we should be optimistic. Things are going to get better. All it takes is a little innovation.

The data seems to be pointing to an economic slowdown of some kind. It is getting increasingly difficult to suggest that we are in for a Goldilocks scenario where growth runs at 3%, inflation drops below 2% and housing starts to recover.

The debate is between those who say we are in for a soft landing or a hard landing. A hard landing is one in which the economy enters a recession. A soft landing is normally defined as one where the economy slows but stops somewhere north of an actual recession.

This week I write from Grand Lake Stream in Maine. It has been a long time since I have taken a week off from writing, but I think this is the week to do it. But that means, gentle reader, that you get an upgrade in quality, as my friends (thanks, Louis!) at GaveKal have graciously permitted me to use one of their most recent newsletters, where they talk about the recent inflation numbers, survey the markets in Japan and discuss Chinese growth and taxes. It is an interesting letter, and I trust you will enjoy it. I will return next week. You can find out more about GaveKal at www.gavekal.com.

Authors: Louis-Vincent Gave, Arthur Kroeber,
Anatole Kaletsky, Pierre Gave

Which is the greater risk: inflation or recession? The markets may be struggling for an answer, but Ben Bernanke has made up his mind: he isn't worried about either!

The economy seems to be slowing. Will this be a mid-cycle slowdown as it has been the last two decades or will it evolve into a recession? In either event, does it presage a bear market in equities? Or is this just another oversold buying opportunity, a gift courtesy of panic selling because of the Israeli-Lebanon situation? If you follow the markets with any sense of history, we do in fact live in interesting times.

But before we jump into our main topics, let's turn our eyes to Israel and Lebanon.

This week's events have made it clear why as investors you need to be able to get a handle on world events. My single best source for commentary on geopolitics is George Friedman and Stratfor.com. ABC News recently said they are able to predict world-changing events in ways that no one else can. They are consistently ahead of the curve with their thoughtful analysis of events all over the world. I caught up with George this afternoon and discussed the situation with him.