March madness is just beginning in basketball and too, it seems, on Wall Street. Friday’s employment release had a bit for everyone, whether bullish, bearish or just confused. The unemployment rate actually rose, while more people were put on payrolls than many expected and overall hourly wages declined. Each portion of the financial market took the news well, and bonds and stocks rallied, while the dollar was the only casualty of the day. In fact, the SPX has jumped enough to finally break out of its three-month trading range, and may just be enough to begin a spring rally in stocks. The other key report during the week was the supply management report, indicating overall business conditions. The report was still above the “strong” line of 50, but has been declining steadily for the past 6 months. Inflation and bottlenecks seem to be dissipating while new orders also softened. So what does it all mean for the economy? We seem to have found a new “happy place”, with growth running above 3%, while inflation continues to be under wraps. What is surprising is that we are enjoying this environment with an active Fed, raising rates steadily since last June. Life in the garden can’t last forever and there is always something to worry about. This week it will be trade, with releases on wholesale and international trade coming out Thursday and Friday.

Alternating between concern over higher oil prices and an improving economy, the markets have spent much of the past three months ducking and weaving with little forward progress. The divergence between the tech laden OTC market and higher oil weighted Dow & SP500 continues with little end in sight. The SP500 and Dow both put in new highs, breaking a three-month trading range. Whether a fake or reality should be determined this week. However, the market internals point to a market in need of a rest, and supported by fewer stocks than the last visit to this territory in November. There still exists a breakdown in some internals, like our smart money indicator registering a two-year low last week and market specialists remain very negative on the market, currently at historically high “short” levels. Both of these indicators do not pinpoint market turning points, but they do indicate risk levels – which we still see as relatively high, even with an improving earnings backdrop.

The “new” technology stocks have been found – housing and the CRB index. Housing stocks, on the backs of lower rates have exploded, up over 700% over the past eight years, surpassing the OTC run. The CRB index is up 67%+ since late ’01, primarily (but not solely) on the back of higher oil prices. Combining the above with a Fed bent on raising rates, and it is little wonder that our bond model is in negative territory for yet another week. The yield curve continues its march lower, currently 188 basis points. This is within 2 basis points of the halfway point between the inverted curve at the end of ’00 and the max last May – a likely resting point, but we are expecting the more likely resting spot to be around 100 basis points – which we may yet see by summer.

© 2005 Paul J. Nolte, CFA
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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.

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