In This Issue:

Sometimes Good News Can Be Bad News
Treasury Bonds May Be A Bubble
It’s Time To Choose Shorter Bond Maturities
Three Ways To Win If Treasuries Decline
Investing In Times Of Extremes
Staying Healthy During Impossible Times
The Bottom Line This Week

The optimistic mood that lifted the stock market two weeks ago didn’t last very long. In fact it might have been the smallest January bounce on record. After the 2^nd, prices started to move back down again.

There is some solace in noting that the market is still up some 20% from where the zigzag rally started on November 21. Despite all the turmoil, it may turn out that the bear market reached bottom at that time. We shall know soon enough.

In any event, by the time last Friday afternoon rolled around, the Dow and the Nasdaq were down 4.8% and 3.7% respectively. During the first three days of this week, the market continued to decline sharply as more disturbing economic numbers were announced.

Sometimes Good News Can Be Bad News

Ironically, one of the biggest worries investors have right now is falling oil prices. A few months ago when oil was approaching $150 a barrel, each decline was met with jubilation. But with oil selling below $38, as it is today, every decline indicates that the economy is continuing to weaken.

In addition, President-elect Obama’s request for an additional $350 billion in bailout money would have been welcomed when the program was new. At the time, the monetary booster shot was seen as a way to get America going again. Now, the need for more funds is seen as a sign that the economy may be in worse shape than investors thought.

Lastly, Citigroup’s (C) apparent decision to sell 51% of its Smith Barney division to Morgan Stanley (MS) would have been welcomed as an acceptable way to prevent Citi from failing. Now the sale looks like the financial services industry is continuing to implode.

Treasury Bonds May Be A Bubble

U.S. Treasury bonds have been a popular refuge from the financial carnage of the past few months. Although Helicopter Ben drove interest rates down, investors can at least be confident that Treasuries won’t default. When the bonds mature, Uncle Sam will pay them at their full face value.

However, investors may be in for a nasty shock if they wish to sell their bonds rather than keep them. The bonds could be worth a lot less than they were when they were purchased.

The problem is that bonds are subject to the same market pressures as any other security. In today’s frightened world, Treasuries are in great demand. But that may not be true tomorrow. When the economic outlook improves, investors will find better-paying places to put their money, and the Treasury bond market will go hisssssss.

Bonds will also take a hit if interest rates start to move up. In that case, older bonds will drop in value because they will pay less interest than new bonds.

In fact, for every 1% increase in the yield of 10 year bonds, investors can expect to see lower-paying bonds drop 7% in price. When the declines begin, bond holders will need to choose between two undesirable options: they can either hold the lower-paying bonds until they mature, or they can sell them at a loss.

Letter to the bank - Dear Sirs, In light of recent developments, when you returned my check marked "insufficient funds," were you referring to my funds or yours? -- Ellen Brown

It’s Time To Choose Shorter Bond Maturities

Unfortunately, Treasury bond declines are likely since all the bailout money that is being poured into the economy will almost certainly lead to higher inflation and interest rates within a year or so. Unprepared bond holders will be caught in the lurch.

The best way to prevent bond losses due to rising interest rates is to roll them over to securities with shorter maturities. Not only will you avoid the declines, you will capture the higher rates that come along. When rates start to level off at some point in the future, it will be time to lock them in by purchasing bonds with longer maturities.

Three Ways To Win If Treasuries Decline

Even better than avoiding Treasury bond losses is to profit from rising rates.

One way is to short a bond ETF such as iShares Lehman 7-10 Year Treasury Bond Fund (IEF). However, we don’t recommend this method because losses can mount up quickly with a short sale that doesn’t work out.

A much better strategy is to invest in an inverse Treasury mutual fund such as ProFunds Rising Rates Opportunity 10 (RTPIX). http://finance.yahoo.com/q/pr?s=RTPIX This no-load fund is structured to move in the opposite direction to the daily price changes in the 10 year Treasury Bond.

More aggressive investors can buy an exchange traded fund that will rise twice as much as price changes in Uncle Sam’s bonds. The most popular of the inverse Treasury ETF’s is ProShares Ultrashort Lehman 7 – 10 Year Treasury ETF (PST). http://finance.yahoo.com/q/pr?s=PST Just remember, the lever can swing both ways.

Staying Healthy During Impossible Times

Speaking of levers that swing both ways, the same is true of the public’s outlook about the future. As we’ve seen during previous downturns, fear can turn to greed far faster than anyone at the time would believe possible. Moreover, the turns often occur when the way ahead looks especially bleak.

We think the foundations have already been laid for some turnarounds later this year. Prices for fine art, jewelry, rare cars, yachts, stocks, and (in some regions) real estate have fallen to ridiculous levels. More importantly, knowledgeable people in each of those markets realize that many items are screaming bargains.

However, few people are reaching for their wallets as yet because they think prices might go even lower in the future. One man we know who deals in expensive watches says many affluent customers come in every week to check prices. If they notice that a watch has been marked down from the week before, they won’t spend a dime. Our client believes the fear of paying too much, and feeling foolish, is a stronger emotion than the desire to get something they want at a good price.

However, when customers see that prices are starting to move up, they will usually make their purchases quickly. Often a buying frenzy begins that can be breathtaking.

We don’t know when the tide will turn for stocks and other valuables that are currently priced very cheaply. We do know, however, that the turn is coming. If you want to make the most of it, you should be in position before the race begins.

When Nothing Works, Quit Worrying About It

We had a client call last week who was beside himself with worry about what to do with his small company. He couldn’t see any way to stay in business. The harder he tried to keep everything going, the more damage he was doing to his health.

Our client’s plight reminded us of a famous psychological experiment that was done sixty years ago. Two sets of monkeys were put in cages that were wired to give them harmless but unpleasant shocks on a random basis.

Both cages contained electrical switches that the monkeys could manipulate. In one cage the switch did nothing. In the other cage, the switch would prevent the next shock from coming – but only if it was used at just the right time.

After a few weeks, medical exams were done on both groups of monkeys. The group that had inoperative switches were fine. But the “executive monkeys” that had to decide how to stop the shocks, were nervous wrecks. Several of them even developed ulcers.

We think the conclusion to be made from the experiment is clear. If you are in a no-win situation that you can’t control, don’t ruin your health attempting to do the impossible. Do what needs to be done to survive the crisis, and live to fight another day.

The Bottom Line This Week

The worldwide economic decline sent a flood of buyers to the safety of U.S. Treasury bonds. As a result, their prices went up and yields declined.

We think the Treasury bubble will begin to deflate sometime in the coming months. To avoid being caught in the trap, readers should roll their maturing bonds into those having shorter maturities. Aggressive investors can profit from declining bond prices by using inverse funds.

Many markets appear to be oversold, and an increasing number of knowledgeable investors know it. The situation is ripe for a rebound that could begin later this year. To participate, investors should take positions early, or be prepared to act very quickly when the turnaround begins.