This week was one of those that woke up a few investors! The markets were looking for a reason to decline and found it in China and comments from Greenspan. China’s markets, in an attempt to rein in the rampant speculation, increased the amount of money investors need to put up to buy stocks. Although it focused upon only those shares that could be owned by Chinese citizens, the ripple went around the world. To top it off, former Fed Chair, Alan Greenspan indicated in a talk (in Hong Kong no less!) that recession in the US is a possibility (after correcting himself saying a probability). Surprisingly, the economic news was actually not too bad on the week, but investors who only a week ago were inclined to view the glass half full, now looked at is as half empty and sold – asking questions later. The selling was so quick and across the board that the markets actually have gone from being overbought to oversold in four trading days. The next big “thing” for the markets will be the Monday opening – to see if the tidal wave of last week has been stemmed or if the selling is to continue unabated. Economically, the employment report on Friday will either confirm some of Greenspan’s fears or at least move it to the bad burner for a spell. Either way the markets are now awake and alert. 

Some of our short-term indicators are showing that the markets may be ready to rally this week, however many others have yet to touch bottom. As a result, a likely scenario is a rally for a week or two that takes the markets up a couple of percent before we enter another down leg that will retest the current lows. One “good” indicator looks at the weekly number of advancing to declining stocks. This past week the OTC market registered a better than 6 to 1 ratio – which last happened in the week following 9/11 – a good market bottom. The mark was reached also in April 2000, just after the initial decline, but prior to a 25% rally before the bottom fell out. Our momentum models are also indicating that at least a short-term rally could ensue and be rather quick. As a result, we are not getting too excited about putting new money into the markets until the dust settles a bit and we get clearer signals from our work. Usually, once the downturn begins, it will take our weekly indicators anywhere from 3-6 months to register a decent buying opportunity. What we may have over the short-term is nothing more than a trading rally.

The only market that fared well was the bond market – however here too are signs that all is not well with the overall economy and actually lends credence to Mr. Greenspan’s comments regarding recession. The yield curve added another 15 basis points to its inverted state, now pushing our model upwards of a 60% chance of recession within a year. The current spread is now only surpassed by the inversion in the last half of 2000, as the economy was rolling over. Whether we get a similar scenario this year remains to be seen, but we are getting very close to that “magical” 60 basis point inversion. 

© 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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