What scared the markets just a month ago now is merely a blip on the computer screen. China’s economic growth rate far surpassed economists' guesses and the markets looked to be taking a tumble on the news, however earnings reports were better than the “low ball” estimates from the street and after a brief decline, the markets put on a show to new all-time highs for the Dow. While the other markets are tracking a bit lower, the gains are nonetheless significant. China and Japan have both indicated that they would be raising interest rates (as they did a month ago) to stem their rampant markets, however after being fooled last month, investors took the cue to add to existing positions. The housing market remains weak and much of the economic data out recently failed to meet initial estimates, but the equity markets continued their march to a different drummer. The coming week will be focused upon housing numbers that should show that housing still has further to go before anything close to robust is once again associated with anything home related. Earnings will once again be the focus (along with the usual helping of merger news) that could push stocks toward the next millennium mark of 13,000 on the Dow. With investor enthusiasm high (see various confidence indexes) and valuations still in the top 10% of historical norms, we still struggle to see how far stocks can rise from here.

From strictly a valuation standpoint, little has changed in the markets since the meltdown of a month ago; with valuations still high and investor euphoria (as measured by Investors Intelligence) is right back to peak levels as are hedge funds “invested” positions. Our daily data is also very overbought, indicating that a decline could come at anytime – however (and there is always at least one!), although investors are bullish, they are acting bearish – by buying options to protect their positions. The Fed has also been pumping the economic pump by increasing money supply – or the grease that makes the economy go – by rates the highest levels in four years. To top off the bullish arguments – merger activity continues at a brisk pace – and it seems no company is safe from an acquirer. April has been a terrific month, but May is usually not so kind and the economic data should still point to a slowing economy once we get past this week. We have been cautious for a while, waiting for better valuations and more worries to enter the market and we may have to wait a while longer, but historically when present conditions exist returns going forward are usually pretty meager.

For yet another week, the bond yield curve is still inverted – widening a bit from the prior week, but still well below the very inverted levels of six weeks ago. Our model remains steadfast at a positive reading of “3”, indicating that rates may yet have further to fall in the future. The discussions regarding higher rates in various overseas markets (specifically Asia) may create further volatility in bonds, but so far – little has changed over the past month. With rates nearing the 4.8% level, we view bonds as a bargain, especially in light of our belief that equities are not likely to provide much beyond a 5% return over the next five years with much less volatility.

© 2007 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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