With the markets essentially unchanged for the month of January, this week will be the determinant as to whether the year is good or bad – as so goes January, so goes the rest of the year. Good thing too that there will be a huge amount of earnings reports (still) and we get the first look at some January economic data – from employment to key manufacturing reports. As a result of last week’s volatility, we expect that this week will be even more volatile as investors try to digest the wealth of information on the economy. We are seeing an economic growth spurt, based on the renewed strength of the data, which is likely to continue this week. Employment data may be bolstered by the usually warm beginning to the year (although we are back to normal now!) and the lack of heavy layoffs in the real estate sector. Earnings season gets its last big hurrah this week before slowing to a dribble in February. So far, earnings growth is around 9.5%, well below the double digits that had become the norm over the past couple of years. With the amount of earnings misses, it should be an interesting week.

With both of our weekly and daily indicators beginning to fall, we are guessing that the markets will likely be trading lower (or at least poorly) over the coming few weeks. The debate within the market is whether the correction will be much more than merely a pause or something more significant. Without a clear crystal ball, our position has been that until certain market drops below certain benchmarks on higher volume. So far, the markets have traded well and within fairly well defined ranges. So, until further notice, the markets deserve the benefit of the doubt and look for higher prices in the weeks ahead. The fact that our indicators are pointing lower may be a function of the trading range the market has entered (from the run higher during the last half of ’06). There are two ways for the markets to work off the excesses – by actually declining, putting fear back into investor’s actions or to trade sideways, frustrating both bulls and bears. Our target for reducing the equity portion of portfolios is roughly 1400 on the SP500, and another one at 1385, then a larger “hole” until 1325. For the bullish, clearing 1440 (the recent highs) would do the trick and force markets higher yet again. With the heavy earnings and economic reports coming out this week – we should see a rather jumpy market.

Bond investors have suffered so far this year, as rates have moved higher with the strengthening economic reports. We still don’t believe we will see any more rate hikes this year, although the comments this week from the Fed meeting will be important to determining their current philosophy. Interest rates have jumped from their December lows of 4.5% to nearly 4.9% as investors shifted their thinking from a “necessary” rate cut to one that is not so certain (in fact more are talking about rate hikes). Housing remains uneven, commodity prices have backed off their recent peaks both had been a concern with the last rate push higher – today it is the fear of a reaccelerating economy. Whether that proves factual or merely fleeting this week’s data should go a long way in determining.

© 2007 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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