We're clearly entering a time of maximum risk for the equity markets. Why? That's simple. We had a massive sell-off this summer, 10%+ and we've not seen a retest yet. Folks, there is always a retest from sell-offs that extreme. That's why I want to highlight this graph from Jeffrey Saut of Raymond James, who has, in my opinion been consistently right about the markets for almost 5 years:

Plainly, the equity markets have rallied on the belief that the Federal Reserve is going to cut the economically influential Federal Funds rate. Consequently if they don’t cut rates, stocks will undoubtedly sell off. If, as anticipated, the Fed cuts rates by 25 basis points (bp), it is likely that rate reduction has already been discounted by the recent stock surge. If, on the other hand, rates are cut by a full 50 bp, we think the markets will interpret that move as an indication the housing/subprime-contagion is a lot worse than the powers that be are telling us. Indeed, “heads I win, tails you lose!”

Indeed, Saut cautions about the same kind of retest of the August lows--which has long been my concern, especially noting that run on an English bank--going into the traditional danger months of the markets, September and October:

While bullish since the August lows, we have always maintained that bottoms tend to be a process involving both price and time. Potentially we have met the “price” requirement given the 20-session, 10% correction, “selling stampede” that culminated on August 16th. That is why we are treating the August lows as an “internal low” until proven wrong. We are now contemplating the “time” component. As previously noted, the 1990 and 1998 correction-sequences saw prices peaking in July, declining into August, and then rallying sharply before retesting those August lows in the September/October timeframe. Whether it plays that way this time remains to be seen, but we are cautious following the initial throwback rally we have experienced into this week’s FOMC meeting.

As I always counsel, hedge your portfolios accordingly. Asset allocation is the key here.

I'm off to Sultanhamet, but before I go the question must be asked: will he or won't he?

Update Click here for the answer.