Summer has finally reached the far northern part of the US – even if it gets only to the mid-80’s, we get excited that it is finally warm. To cool down on those hot summer days, hanging out at the pool is the ticket. The economy seems to have taken a dip as well, just not into the neighborhood swimming hole. What remains to be seen is if the respite to cool off does not transform into a drowning. The markets are acting as if the economy, and by extension, corporate America is in trouble and should be tossed a lifeline. While earnings news has generally been good, a few standout “misses” and reduced guidance caused investors to sit in the serenity of cash. Greenspan, the lifeguard on duty, will be addressing the economy in front of Congress, regaling everyone on the positive characteristics of a slow and steadily growing economy. With nearly one-third of the SP500 reporting this week, the trading days through the remainder of July could set the tone for the party conventions (it’s the economy, stupid). For our part, we have been fearful of getting into the water, wondering what may be lurking beneath the surface. Until the murkiness clears, we will be in the shade of a parasol waiting for the all clear.

In a repeat from the last week, the OTC market looks to be taking the other averages lower. And based on their respective weights in the technology sector is how they faired – OTC worst, Dow best and the SP500 in the middle. Value beat growth and small lost out to large. This is the theme that is beginning to emerge at the halfway point of the year. From a technical perspective, all the markets have been sold pretty hard and a bounce is to be expected, however any rise that is not met with rising volume will continue to be suspect. This week provided another example of persistent selling, as only one day (7/13) did advancing volume beat declining volume, even though advancing stocks were ahead of declining stocks (on the NYSE) everyday but one. Looking at data from the Rydex funds, we compare the amount of money in “bullish” funds to assets in funds that benefit from a declining market. As of yet, we have not seen a dramatic shift of assets, as overwhelmingly most remain in funds anticipating a rising market. We use this as a contrary indicator, when everyone is bullish, we should be bearish and vice versa. Until more investors become worried that lower markets may actually be in the future, we remain worried.

What has been bad for stocks has been a boon to bonds. The bond model is now 5/5 positive, pointing to still lower interest rates in the future. Commodity prices have leveled off a bit, inflation figures are better than most expected and bonds as well as utility stocks have rallied. In what until recently has been a complementary indicator; during the bear market a positive bond model reading has actually been bearish for stocks. While the model has gotten into gear with stocks during the ’03 rally, the early divergence is a concern.

It is amazing how similar today and two years ago look. July ’02 saw the market sell-off into the first of three separate bottoms before bulling its way higher. Then, as now, technology, airlines and broadcasting stocks were on the bottom of the pile, with consumer and mining issues at the top. While we expect the parallels to stop there, we are hard pressed to see, as yet, any signs of a bottom in technology names. Led lower by semi-conductors, technology stocks have been falling on increasing volume for three weeks, not a sign of bottoming. While the media has been focused on Ken Lay of Enron and Martha Stewart, oil prices have once again poked above $40 per barrel and provided some life to oil stocks. Drilling activity has not shown signs of slowing, as new rigs are being put in place weekly. The major oil stocks are just now matching or surpassing their highs of ’00 and ’01 that could mean even higher prices ahead. Many of the drillers have been in trading ranges for the past three years, and too are approaching prior peaks that could propel them higher as well. Finally, one group that was on the ropes early in the year as rate increases were on the horizon, REITs have gained renewed strength as the “measured” increases in rates are becoming more a possibility with every economic release. Instead of playing via individual stocks, a diversified fund is the best way to go with this group.

We have increased our position on the “short” side of the market, concentrating on technology related issues. We are reviewing our remaining holdings in small cap stocks; especially the little we have left in growth type funds, as they may be a source of cash for us if the markets are unable to right themselves. Portfolios concentrated in individual stocks have been focused on energy and consumer names, two groups we feel should hold up well under market “stress”. Any further breakdown in stocks, no matter the source, will cause us to increase our cash position. Look at 1090 on the SP500 and 9900 on the Dow as key levels that need to hold.

© 2004 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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