The biggest question of the week is: if the economy is doing so poorly, why is the stock market cheering? Based upon the GDP report, economic growth in the US is a measly 1.3%, way below what even the most pessimistic economists believed. As with any bit of bad news, there is always a silver lining – and here the blame rests firmly upon the housing slump. Next week we get the “big” economic reports that tend to move markets: employment and purchasing managers reports (ISM data). Either these reports will confirm the GDP report or they will point to a one-quarter wonder and investors will continue to cheer stocks higher. The current guess (as good as it gets in this business!) is that payrolls will grow by roughly 100,000 with a fairly wide range around that figure. The new focus will be on inflationary components to the employment report, as the GDP report showed prices rising at still uncomfortable rates. So the Fed continues to balance between higher than desired inflation and below the full potential of the economy – a spot the economy was in during the bad old days of the 1970’s. However, any comparison between today’s lackluster growth and modestly higher inflation and the rampant inflationary figures of 30 years ago would be erroneous – save for the ties to the energy markets. Housing will continue to play a key roll in the economy and its future over the next few years.

If the markets can rise on Monday, the Dow would have increased in all but two trading days for the month – a terrific feat. However, there were nine days in which there were more stocks that actually fell in price than rose – masking the strength of the Dow. What makes this “record” more interesting is if the volume were ranked from highest volume days during April to lowest, of the top eight volume days, six were when the declining stocks were higher than those that advanced. Among the slowest eight days, only three were on “down” days. In fact, of the 80 trading days so far this year, six of the top ten volume days came when more stocks declined and the slowest ten days saw only three. We have argued for some time that the markets are not acting “bullish” – even though they continue to rise. Top it off with a bit higher interest rates than yearend, bullish sentiment among investors and valuations that remain among the highest in history and we are left wondering how much gas is still left in the market’s tank. While we are not yet prepared to sell it all and hit the beach for the summer, we will be watching for additional cracks that may force us to take portfolios to higher (and safer) ground.

In the face of rather bearish news regarding inflation (still too high), bonds have acted rather well falling modestly over the past week. The bond model remains in bullish territory, indicating that rates could actually fall in the weeks ahead. The CRB index, the final arbiter of things inflationary (gold, oil and various industrial materials) is actually modestly lower over the past five months, reflecting the lack of huge demand for that basket of goods. While oil prices continue to rise, putting a large dent in consumer’s wallets, it may also cause overall spending to slow as less left over once the tank is full to spend on other goods – so watch what the retail companies say about sales in the weeks ahead.

© 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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