So maybe the vacation season got extended a bit for those on Wall Street, as volume barely rebounded from the very low late August levels. Injected into the mix were comments from various Fed officials about the still concerning high level of inflation, causing the markets to decline mid-week. However, if inflation were really the big concern that many believe, then why has the 10-year bond declined in yield 50 basis points – and barely budged once the comments were made? Could it be that the bond market is more worried about slower growth than inflation? The economic numbers of the week did little to move the markets and did little to support a robust economy. We get the trade numbers and the CPI figures that should be a focus late in the week. Since the inflation figures were so large a year ago, we will be dropping them from the annual figures, so even if the monthly inflation gauge is “above expectations” the annual figure should decline some. When looking at oil, for example, pump prices are actually down a bit from those of a year ago and the price of crude is looking like it may break the long-term ascending trend line of the past two years. Inflation may not be dead, but it has taken a few body blows.

Since this is September, anytime the market declines, investors toss up their hands, blaming the seasonal tendencies of the market to decline. However the markets rarely conform to the consensus view, which is a decline for six more weeks and then a nice yearend rally. Our indicators have turned up with the August rally, and are currently showing no more than a mild correction over the next few weeks. In order to inflict the most pain on investors, a mild rally during Sept/Oct would get everyone excited for a rollicking yearend rally that may not materialize. Sentiment is on the negative side, as investors have been buying “insurance” to protect against a decline. The technical picture is back into no-man’s land, but not indicative of an impending large decline. Of course, outside curves will always have an impact – especially as we remember those who perished five years ago. The global political environment is always in the background, but investors may be beginning to focus a bit more on the mid-term elections that could have a lasting impact upon both economic and foreign policies.

The bond model has every indicator in gear, now at the maximum reading of “5”. Our readings of the indicator puts a “3” reading on level par with a “5”, it is nice to see the CRB index begin to decline a bit, taking some additional pressure off of the inflation discussions. We are still in the camp that believes the Fed is likely done with this interest rate cycle and will soon embark upon a rate cutting cycle sometime after the first of the year. While lower interest rates are generally good for stocks, short-term interest rates remain well above year ago levels, and still above long-term rates. This bond picture is not usually associated with higher or rising inflation, but usually the ending of a tightening cycle.

© 2006 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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