In what is becoming a broken record (and this time positively), the markets once again eked out a gain. The real story last week was the decline in interest rates, as investors feared a deflationary environment. While the PPI and CPI figures indicated a lack of pricing pressure, the CRB gained on the week, indicating there were some prices willing to go up. While earnings reports generally were good for the week, the “forward looking” comments still showed a restrained environment. The goal of the Fed has been price stability, now that we essentially have “stability” somewhere close to the zero point; everyone is worried that we are going to fall down the deflationary hole. The coming week will offer little from the government in the way of economic reports, and the quarterly earnings parade is also near the end. So what will the market feed off of this week? Rumors, lies and damn lies. Much of the worrying will depend upon the day of the week: the falling dollar, bombing in the Mid East or corporate pronouncements could sway the market this week. So far, until proven otherwise, the market looks to continue its slow climb higher.

Just how persistent has the market been? During the 21 trading days of April, the market had only six days when there were more declining issues than advancing (one day was a standoff). So far in May, only four had net declines, with two days less than 100 issues difference. The numbers are even better on the OTC market. All of this “good breath” has translated to better performance by the mid and small cap stocks, which have been outperforming the large cap stocks. Last month, small bettered big by approximately 150 basis points. So far in May, it has been nearly 200 bp. The market internals continue to point to a correction, however so far, there has been a lot of bending, but no breaking. The market leadership has shifted toward the smaller stocks, as evidenced by the Russell gains of over 20% from the bottom vs. a 15% gain in the SP 500. The technical position of the market remains “overbought” implying that a decline is near, however an overbought position (like an oversold one) can remain in place for more than a couple of days (or even weeks). The rally so far is different than the past rallies in bear markets, as this one has actually clear prior peaks (see OTC, Russell and SPX), advancing stocks have been well ahead of declining ones and selling days are not being met by additional selling on ever more volume. Volume has been the key, and so far it is point bullish. Whatever correction comes should be shallow and short. As such, we would be using the decline to establish or add to existing strong positions.

We still like IKE. With bond rates at their lowest levels since the glorious 50’s (they were, weren’t they?), bond investors have been giddy with their gains over the past three years. In just two weeks, the yield on the 30 year bond has declined by nearly 40bp – a decline in percentage terms that has been matched only once since 1989 (Early Nov ’01). However, in ’01, long rates quickly backed up; rising from 4.95% to 5.55% in a matter of five weeks. The bond model remains at a bullish 4/5, and will be monitored for any signs of weakness. The fears of deflation may be overwhelmed by fears of a lower dollar, which could push rates back up in the weeks ahead.

If we are to gauge the current rally as a “bull” rally, the first requisite is to surpass prior peaks, putting in a higher high after a higher low. The focus over the past six weeks has been on technology issues, as they have fallen the furthest and small moves can provide very high returns. Using our momentum measures, the technology sector has put in a series of higher lows, and now two higher highs. Going down toward the sectors within technology, the semi conductors have been able to put in higher lows, but as of yet, not higher highs. Computers have been able to complete both requisites. On a price basis, DELL looks to finally be breaking out of its two-year range between 20 and 30. Smaller stocks like Lexmark (LXK), Hutchinson Technology (HTCH) and Western Digital (WDC) are really leading the sector higher. Communications technology has been a leader in the tech sector. In this group, small stocks dominate; Adtran (ADTN), Allen Telecom (ALN), Foundry Net (FDRY), Packeteer (PKTR) and Trimble (TRMB) are among the standouts. Sector favorite, Cisco (CSCO) has been improving of late, and may be playing catch-up with its smaller rivals. Finally, the very broad software group only three look to have hit the “daily double” Fair Isaac (FIC) Hyperion Solutions (HYSL) and Intergraph (INGR). With the weakness in the semiconductor book to bill reported last week, it will be interesting to see if the tech sector can continue its climb higher.

Not much has changed in our position from the last two weeks. The market advance seems to be slowing, but no definitive break yet. We continue to expect a correction over the coming three to six weeks that could retrace about half of the 15% gained from the March lows. The dollar weakness may be the key to equity weakness.

© 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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