Save for option expiration Friday, the market put in another dull week, rising everyday on light volume, it reminded us of watching grass grow. However, as of today, the SP500 has made it to just above breakeven territory for the year, although still behind money market investments. Another relatively light economic and earnings week should divert investor’s attention toward the oil and dollar markets, where recent trends to lower oil and higher dollar have reversed. Oil prices are once again attacking $60 a barrel as concerns regarding capacity of refineries put a spark into an already volatile market. The dollar and bonds fell stopping their recent surprising increases. With the momentum (what there is of it) behind the market, we could see higher prices over the coming weeks, even though a short-term correction may be in the offing. So why should the markets rise? Investors have been watching the Fed, and hoping that the economy is going to be weak enough to force them to stop the rate hikes. History tells us that once the Fed is done, stocks rally – so investors are betting upon a one and done. IF the futures markets are correct, it looks like we have at least two and a better than 80% chance of three before the Fed is done, something investors have not yet figured into their formulas.

With investors getting exciting about stocks again, it may be time for an ill-timed market correction. However, unlike a big, serious downdraft, we think any correction here could be relatively short and benign. The real concerns will be later in the summer once the markets regain the highs for the year. Valuation concerns remain front and center, with the SP500 selling at 20 times earnings – and up until 1997 that marked the high water mark for stocks. In what is fast becoming the “new-new” era, we are hearing more commentary about the market being the cheapest in nearly 10 years. True, but for eight plus years, the markets were overvalued to wildly overvalued and now back to overvalued. The current technical picture is pointing to a correction, as investors have been piling into stocks, as evidenced by nearly 60% of all trading volume over the past five weeks has been focused on advancing stocks. We note, however, that it is not because advancing volume has picked up (only 120,000 shares per day), but declining volume has dried up (falling 3.25 million per day). Since advancing and declining volumes ebb and flow, we expect volume to flow back to the sell side and ebb from the buy side to temporarily provide balance between the two.

Even with the backup in long-term rates and the CRB index, the bond model remains steady at “3”, a buy for long dated bonds. The current thinking in the bond pits regarding the Feds intentions toward rates is that we are 100% certain of the next two increases (June & August) and an 80% chance at another in the fall. The keys to further increases may lie with the economic data released between now and August. We expect to see a much weaker economy come early fall and could force the Fed to the sidelines. For now, we will focus on the 7-10 year maturities, as they should provide the best risk-reward profile over the next six to twelve months.

© 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.

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