The DJIA was down 2.72 % for the week as at Thursday, but the small cap Russell2000 declined a huge 5.26 %; leaving it with a miserly 0.48 % gain for the year.

The tech-laden Nasdaq, which recently had been showing signs of gaining favor with investors, reversed direction this week, and declined 3.27 %.

All in all, blue-chips held up better than small caps, tech stocks and the average stock. As the sub-prime loan contagion began to spread, investors became more risk averse, and the private equity people had trouble funding their buy-outs, which led many to believe that the party for private equity was over. [Blackstone's share price hovers between $24-$25; 23 % below its IPO of $31.00]

As cheap debt disappears the stock market loses one of it's major supports, and investors can no longer count on shares of small and mid-caps being bid up to insane levels in hopes of a buy-out by private equity. In the Homebuilding sector D.R. Horton and Beazer Homes posted sharp losses and reported that first-time home owners were facing difficulties getting a loan. The housing sector continues to bleed.

In yesterday's market rout, with the DJIA falling 311 points, the Basic Industries, Transportation and Energy sectors-key sectors dependent on a booming economy- fell the most . The combination of weak housing market, sub-prime  loan defaults, rising cost of debt and high oil prices led investors to believe that the economy faced a real slowdown this time. With a slowdown in the economy, demand for Transportation, Energy and Basic materials will decline.

Transportation bellwethers Burlington Northern and UPS posted weak earnings and announced that demand for freight services was expected to decline. Even crude oil futures declined by 1.2 % from $77 per barrel to $74.95.

Investors fled to the safety of fixed-income assets and the price of the 10-year Treasury soared, with the yield falling to 4.80 %, what a big difference from 5.25 % just a month ago. 

Sector Talk 

Two important pillars of the U.S. Economy are in decline as they face the problems posed by sub-prime loans and the loss of confidence in the debt market: Homebuilding and Banking. While Homebuilding has been in a stage of decline for quite some time now because it also faced issues associated with oversupply and bubbly prices, the banking industry has only recently begun to feel the crunch. In addition to possible exposure to bad loans, banks also face an environment of lenders becoming more risk-averse and demanding more for their loans; and a worldwide general rise in interest rates as the Asian and European economies continue their growth.

If only we knew where the bottom was, we would be able to get in at good values for the rebound; especially as Homebuilding and Banking's contribution to the U.S. economy are very significant.

What's Hot

Tune in to CNBC or any program that features interviews with half a dozen super-star analysts; and they will be almost equally divided on whether the market is headed down or still has strength to power on. The truth is: nobody knows what is going to happen next as the market digests a confusing mass of both good and bad news.

On the one hand you have Oil definitely over $70 per barrel, and real signs that people are taking the sub-prime mortgage fall-out seriously. Lenders are getting more risk-averse, banks raising cash to fund private equity buy-out deals are having to sweeten their terms or to fund it themselves. [Cerberus' buy-out of Chrysler, KKR's buy-out of Alliance Boots, Carlyle's buy-out of GM's Allison Transmission Unit.] Blackstone's stock price is at $24.80 [below its IPO of $31], and fall-out from Bear Stearn's closure of two hedge funds that had exposure to sub-prime loans continues to spread. But on the other hand we have Blue chips  continuing to post double-digit gains [Merck, American Express, IBM etc], American jobs still plentiful, and consumers who are still spending, though there are signs that high gas prices are crimping their discretionary purchases. No wonder nobody can agree on whether it's time to buy, sell or wait on the sidelines.

Another important development that puts a negative side to the whole equation for the longer term is the increasing willingness of rich foreign governments to invest their reserves in equity; instead of passively buying U.S. Treasuries. Just this week we have the Singapore government's investment company Temasek Holdings, teaming up with the China Development bank to invest in Barclay and help it up the ante against Royal Bank of Scotland's consortium in the bid for ABN Amro. State-backed Dubai International Capital has spent billions building up stakes in HSBC Holdings, Airbus maker European Aeronautic Defence & Space Co. and India's ICICI Bank Ltd. Meanwhile the Qatar Investment Authority made a $21 billion bid for British supermarket chain Sainsbury.

The final result of all this activity would be to bid up the price of equity assets, at the expense of bonds, thus raising their yield. As interest rates increase, the U.S. stock market may then undergo a major correction. On balance, we see a slightly negative environment going forward.

 In such a situation there is one thing you can do: Put 90% of your investment funds in a slow and steady, non-volatile portfolio and 10 % in a more volatile portion that can turbocharge your portfolio performance.