RED FLAGS ARE FLYING

I have lived by the beach most of my life, and swimming and surfing are two of my biggest passions. In my younger days, I spent six years as a lifeguard in Newport Beach, Calif. Those beaches can pose significant risks during the summer, especially when big southern swells roll in.

In Newport Beach, we developed a system designed to warn swimmers when those big swells created a dangerous situation. We lifeguards would fly colored flags on our towers to alert swimmers about the condition of the current. Green flags represented calm waters, yellow stood for caution when swells rose to 3-5 feet, and then the dreaded red flag was unfurled to tell inexperienced swimmers that they should not go in the water. Red flags are there for a really good reason — they are designed to warn those who may not be aware that conditions are hazardous.

Well, when I look at the stock market right now, I see a whole host of red flags.

Banking and financial stocks are sinking under the weight of the subprime mortgage bond meltdown. I know that many people do not understand how subprime mortgages could be hurting the financial sector as much as they are, since subprime loans only account for a small portion of the total number and the overall dollar amount of loans. In fact, most banks don’t even hold mortgage loans in their portfolios any more.

To get a really thorough understanding of how this subprime mess is hurting financial stocks, I want all of my Alert subscribers to read what my good friend John Mauldin wrote about this situation. John is a great writer and an investment genius, and he does an excellent job at explaining the complex issues surrounding the subprime mortgage mess.

His weekly e-letter, "Thoughts from the Frontline," is a must read for me, and indeed anyone with a thirst for intelligent market commentary. This past week’s issue is entitled "Where is the Real Risk in the Subprime Debacle?" and I strongly suggest that all of you check it out.

To access John Mauldin’s great piece, just click here.

Another red flag that I am watching right now is the meltdown in real estate stocks. That meltdown clearly is demonstrated here via the chart of the Real Estate iShares (IYR). The slide in this sector has been fast and furious, and as more bad real estate-related news keeps flooding the media, the prospects for this sector will continue looking poor.

Finally, the failure of broad-based equities to break their June highs and the return of the S&P 500 to its 50-day moving average (blue line) are two more red flags that concern me.

What we could be seeing here is the beginning of the end of the bull cycle in equities that began in March and now is showing serious signs of weakness.

Before you commit any of your money to this market, it pays to be aware of the numerous red flags flying from those lifeguard towers. Who knows, paying attention to those market red flags actually could save you from drowning financially.