The lights went on, the buyers came back, and the market once again moved higher. Led by technology issues, the rally ran out of gas, ironically, when the bellwether for the group, Intel (INTC) said sales were above expectations. After jumping in the morning, the markets fell the remainder of the day, finishing on their lows. However, for the week, all the markets finished higher. The economic numbers continue to point to a recovery, which the equity markets seem to be ignoring (by virtue of their relatively unchanged levels for the past 10 weeks), however the bond market has taken notice, as long bonds have increased by over 100 basis points in yield since mid-June. The summer “rest” is nearly over, as the grills get fired one last time over the Labor Day weekend and vacationers go back to school and work, volume should pick up and the markets should break from their summer slumber. The direction remains somewhat in question, however the bulls have the floor and have not yet yielded to the bearish camp. More economic numbers this week, with sentiment and durable goods leading the list.

While the large cap index (SPX) has treaded water for two months, the Russell and OTC markets continue to drive higher. Friday’s action, by itself, could signal a turn for the markets as both opened higher and finished lower – completely encompassing the prior days trading range. These “outside” days generally signal a change in overall directions for the markets. The one caveat is trading volume (again!) should be high. This was not the case on Friday, as overall volume was actually below Thursday’s trading. Monday should be an indication of whether the market is beginning a correction or will break the trading range of the past two months. The longer term technical condition of the market remains vulnerable to a correction, however the shorter, daily data indicates a short-term bottom. Why the divergence in opinion? The short-term indicators generally are “good” for only the next couple of weeks; while the longer-term indicators are for the next few months. We do keep monthly data, which is good for the next few years. While we expect trading volume to remain light during the week, the markets are likely to react better to the economic data, as little in the way of important company news is scheduled for release.

The bond model is stuck in the mud at 0/5 negative. We continue to hedge some of our bond holdings, expecting rates to continue to slowly move higher, unlike the past six weeks. The steep yield curve is also of concern, as we have mentioned repeatedly over the past few weeks. Until the curve begins to flatten, (with long rates coming down) little in the way of long-term economic growth will develop. The Fed is pumping money into the economy, using the growth in the various money supply bases (M1, M2 and M3), at a rate well above 8% over the past year. If the Fed keeps their collective feet on the gas pedal too long, inflation rather than deflation will result in the years ahead. IF gold is an indication, the two-year rally may be indicating some inflation is already in the system.

One indication of the broadening of the market rally is to look at the S&P 500, as it compares to the various weekly rankings that we do. During much of the late ‘90s the SPX was generally ranked between 30 and 50 out of 112 groups and at the market peak, was ranked in the top quartile. However, beginning in ’01, the SPX has generally ranked between 65 and 90, and only recently broke into the top half. What this means is that many more sectors of the markets are beating the SPX, instead of the other way around (remember the argument for so few beating the index?) Today, small and mid cap stocks have shown brightly vs. the large stocks and will continue to do so until the SPX rankings begin moving back toward the top half of our system. Financial stocks, the harbinger of a good economy, have been performing poorly of late, moving from the top to the bottom half of our rankings. Banking and S&Ls have generally been the big winners during the last couple of years, as interest rate spreads widened and mortgage activity jumped. However, their relative rankings have deteriorated over the past two weeks and warrant a review. From example, last week, Wells Fargo (WFC) traded above the prior week, and finished below and relatively heavy volume. Among banking stocks that reversed course, Citigroup (c), JP Morgan (JPM) and National City (NCC) all have three weeks ago. The brokerage stocks, bolstered by the advancing market have yet to roll over, however a decline in the group could presage a market correction.

While the market can continue to move higher, we await a break of the trading range the markets have been bound within on relatively heavy volume. The foreign markets as well as small and mid cap stocks continue to outpace the SPX. Although bonds can rally (as they have sold off dramatically) we view any decline in rates from here as a correction to the new change in direction for interest rates – higher.

© 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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