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Sideways for 2006?
by Paul J.
Nolte, CFA
January 23, 2006
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What a difference a week makes, from improprieties in the Japanese markets to still higher oil prices amid diplomatic rumblings in the Middle East to less than stellar earnings. So what is an investor to do? Based on Friday’s response, it may yet be a long dark winter. While we were confused by the rally early in the year (following a poor Christmas season), we are just as confused by the one day decline. Investors may not want to be holding securities over the weekend with the diplomatic uncertainties looming as well as an expiration of options adding to the volume figures. The economic numbers (not to change the subject) confirmed what we had already been expecting, a slowing housing market and still low inflation. What the earnings season may be showing us are the persistently higher producer prices vs. consumer prices may finally be taking its toll on margins at the corporate level. Even with the lower than expected earnings, companies are also boosting dividends, an indication that cash just may be burning a hole in the corporate pocket. So while we feel the market should work lower over the course of the year, Friday’s big decline may closer approximate a short-term bottom than the start of something big. While we laid out the likely path of the market over the coming weeks, likely more grinding and some headway, but little overall movement. That was blown out of the water Friday, but we still believe some “recovery” gains are likely in the weeks ahead before we get a bit more serious about a decline. Volume Friday was helped by options expiration, making a bad situation look worse. For the week, the net advance to declines was not as bad as we have seen in other negative weeks. While one day does not make a trend, the market had been doing OK up to that point. So now the major averages are back to square one (small stocks and overseas still have gains), what lies ahead? Based on some follow-through to Friday’s action, the week could start poorly, but should finish well as investors snap up perceived bargains. The daily data, with Friday’s activity has turned lower, but the weekly data continues to be in “no man’s land” and well off of levels we would anticipate a declining market to ensue. So after some fits and starts, we anticipate that the markets will once again settle into the sideways pattern that has marked the past two frustrating years in equities. The yield curve continues to flatten, with the spread between 13 week Treasuries and 30-year bonds now only 14 basis points apart (cut in half last week). While an inverted curve (short rates above long) is likely to occur once the Fed pronounces their much-anticipated 14th rate hike of the cycle. Our bond model continues to indicate lower long-term interest rates are ahead with a “3” reading. How much further the Fed will push rates becomes a function of the strength of economic data we will see in the months ahead. We expect the data to show a slowing economy and would expect the Fed to “stand aside”, however the incoming Fed chair will want to demonstrate he is an inflation fighter and may continue raising rates beyond what would be necessary, potentially pushing the economy into recession.
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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