The home team is driving down the field, getting ready to score to win the game. The war is being discussed more like a football game than a war, replete with analysts second guessing the “plays”, “ex-players” (retired military) providing insight to the “game”. Finally, the play-by-play provided by any number of outlets. The trouble with the “game” is that it is on 24/7 and although there are injuries, there are also deaths that create a sense of panic when reported. As much as Gulf War I was a “push button” war, this one has much better graphics and is instantaneous. So, what does this all have to do with the financial markets? It is the instantaneous news, second guessing, and sense of drama created by those reporting that are pushing and pulling the market higher or lower, depending upon the news reported at the moment. Rumors take on a life of their own and get rapidly circulated. It also creates a ready excuse for any number of economic reports that are disappointing, yet another casualty of war. Conventional wisdom is that the economy will once again boom (or at least grow) once Iraq is “solved.” However the hole that is being dug keeps getting deeper and will require a Herculean effort to climb out. Now that the troops are in Baghdad, the markets may well rally on Monday, however at some point their eyes will begin to focus on the poor economy and reevaluate the overall level of stock prices.

The bias of the market was positive on the week, even with a few reported earnings misses late in the week. The beginning of earnings reporting season will be opening this week and will be in full force over the next three weeks. The internals of the market resembled more of one marking time, waiting for more information from Baghdad, on earnings, and possible rate cuts. The market internals on a daily basis are very slowly working off their overbought position from last week. The advance decline line made a modest improvement over the week, while on a weekly basis the advancing stocks were nearly double those that declined. With the first quarter officially closed, and again negative, maybe April will be a bit better. Historically, April (no longer December) is the best month of the year. The only drawback is that it usually signifies the end of the seasonally better part of the year (beginning November, ending in April). The longer-term indicators remain positive (as they have been over the past three quarters) and if the market is “normal” a 4.75% return would be an average return under current circumstances. The Fed model comparing interest rates to the market PE has been registering a “buy” for a while, however modifying it for BAA corporate bonds shows that it is merely in the normal range. As usual, nothing is cut and dried. A slight positive bias exists in the markets that may be changed with an ending of the war.

Interest rates have calmed down some, at least when looked at from the end of the week. However, depending upon movements in the equities, investors either clamor for bonds or sell bonds and buy stocks. The bond model actually improved a notch to a positive 4/5 as T-Bill rates fell just enough to add short rates to the “buy” side. The bond market has begun to discount a Fed easing in rates of at least 25 basis points by June, although a May move is not out of the question. Since the bond model turned positive four weeks ago, the stock market moved up by 6%, its best showing since early ’99, just maybe the bond and stock markets have again recoupled.

If the market is destined to rally, where is the action in the groups? Strength is starting to show up in many of the cyclical groups as well as in the very beaten brokerage sector. For example, the very long term indicators (lasting for more than 1 year) are beginning to turn positive for Merrill, Lehman and Morgan (MER, LEH, MWD) in the brokerage group. In fact, both stocks have shown reversals (lower lows, and closes above prior highs) in weekly data over the past month. Also LEH has and MER and MWD are near breaking two-year downtrends. If this group is able to right itself and provide some leadership, it will lend credence to a bull-run in stocks. Retail stocks are also coming to life, after the mauling Sears (S) took after missing earnings, the possible sale of their credit card division has put some life in the stock. Others in the group that look better, Wal-Mart (WMT), HD (Home Depot) and even lowly Radio Shack (RSH) has possibilities. In order for the market to continue a bullish run, these groups will need to continue participating. If they falter, it could be the end of the latest bull in a bear market. The war has had some impact on the broadcasting arena, as revenues are likely to be weak from the 24/7 coverage of the war. Many in the sector, including Viacom (VIA) and Disney (DIS) have had short and sharp rallies, only to turn lower and put in new lows. IF the war ends soon, the stocks may turn higher as “normal” revenue flow may return. Much hangs on the ending of the war, and more importantly, the aftermath and dealing of the inevitable problems that will come up.

Little change in our outlook: while the market remains focused on the Mid-East, early signs of a better environment are beginning to emerge. There have been “false” signals in the past, so we will watch for any deterioration. Any changes will be slow, as the bullish case will need to be “proved” before we get aggressively bullish. For now we are hopeful.

© 2003 Paul J. Nolte, CFA
Editorial Archive

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.

CONTACT INFORMATION
Paul J. Nolte, CFA
Director Investments
Hinsdale Associates
630-325-7100
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