Unless we get a huge day today, January will finish in the red – and EVERYONE knows what happens then: a down year is all but guaranteed. I did a bit of culling from the historical record and came up with a few tidbits for everyone to chew on. With the recent exception of Reagan and Clinton, the first year of a president’s second term (follow?) has always been negative (going back to Lincoln’s second term). Also, going back over the past fifty years, this year ranks up with ’57, ’77 and ’81 as poor Januarys in a president’s first year of a term – the average return for the year was a loss of nearly 12%. So unless we hear and see terrific things from this president on Tuesday’s State of the Union address, we could be following history a bit closer than we would like. The whiff of an economic slowdown was felt on Friday with the GDP report, hurt further by our poor trade picture. The coming week will provide enough fodder for both bulls and bears to push market volatility higher. Our economic thesis for ’05 has not been seriously challenged by the reports yet, the coming week will either confirm or deny the slowing economy and lower inflation picture we have drawn up for the year. That being said, we also expect Friday’s volatile employment report to surprise investors with strength, but look for still moderate wage growth.

As we alluded to above, the presidential cycle does not favor the first year of anyone’s term, especially those who have successfully navigated the elections twice. Our economic outlook adds to the gloom and is one reason why we remain cautious toward the market this year. We highlighted the volume trends so far in ’05, and last week did little to change the early indications. So too the “smart-money” indicators maintained their downward bias. The divergence between the weekly and daily data is nothing more than the difference between a short and long-term look at the markets. The daily data may be indicating that a short-term bottom was put in place last week, and the market should begin to trade better in early February. However, the weekly data has turned lower (and moves slower) and given historical movements, is indicating that a bottom may occur around early summer. So while a rally may ensue, we would not be surprised if it were relatively short-lived and gain but a few percentage points before rolling back over.

The bond market took a siesta last week, with many of our indicators moving very little. The model remains positive at 3/5 still indicating that interest rates may be falling in the future. Lending some support to our feeling that lower rates are ahead is the consensus of investors as well as economists that rates must increase. As part of the consumer confidence survey, interest rate direction is a component. Over 80% of households believe rates are going up, while the Conference Board has 70% confident of higher rates and not to be outdone, a survey of manufacturers shows over 90% confident of higher rates. Our simplistic take is that when everyone is on that side of the boat, it might be a good idea to be on the windward side.

© 2005 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
Email