Street Sense, what everyone aspires to, even after many years of paid education – an understanding of the way the world works, not the way it does inside of a textbook. Street Sense also was the first Breeders Cup juvenile to win the Kentucky Derby. Street sense is also what many investors believe they have when it comes to Wall Street, however bull markets tend to make everyone look smart. The continued increase in stocks is flying in the face of a decidedly weakening economy. On top of a poor GDP report last week, the unemployment picture continued to show a slow hiring pattern. Over the past year, non-farm payrolls have regularly come in below the prior twelve-month average. Although still a ways away from actually declining, the trend is definitely lower – and has been for well over a year. The flipside to the economic numbers has been the huge amount of merger news – from Tribune to Dow Jones News. Everyone is combing their favorite screens to ferret out the next possible takeover candidate. The Fed will meet this week and likely keep rates right where they are and the key is going to be what they have to say about both the economy and inflation. Given the market’s belief that the economy is doing just fine (hitting a rough patch) and inflation is (or will be) coming down (housing slowdown), the commentary from the Fed could key a large market move in either direction.

We continue to be struck by the overall weakness in volume – lower volume on rising prices that has been a feature of the market for the past month. Some weakness is also beginning to show up in the number of stocks making new highs – their numbers are dwindling, from as many as 465 in early February to 450 in mid-April and under 350 on Friday (only 105 on May 1^st). Over this same span, the Dow has been leading the way, with the broader SP500 following close behind. The smaller stocks have not participated to the same extent. Since Feb 22^nd, the Russell index of small stocks has essentially been unchanged, while the SP500 has increased by nearly 3.5%, and the Dow has jumped 4.5%. The markets are beginning to thin out with fewer stocks driving the averages higher. While we have been shifting money toward larger stocks, the narrowing of performance is not a healthy trend for the overall averages. Put this into the category of signs of a topping market (which is getting rather full). However, though the signs point to a top, we unfortunately won’t be able to pin point the actual day of the turn until after the fact – guessing when the turning point will come is dangerous to one’s wealth.

The bond market seems to be laughing at all the worrying about inflation, as 30-year bond yields are exactly where they ended the year, while short rates have moved a smidgeon lower. Our bond model, save for a six-week “vacation” early in the year, has been pointing to lower rates since July of last year, when both rates were at 5.1% (now both around 4.9%). The concerns about gas prices reaching $3.50 or higher this summer as a sign of a new round of inflation is more likely to put the brakes on consumer spending, as the rise in prices has already “cut” wages by nearly 2%. With the consumer unable to draw from home equity and overall debt levels already high – this could be a long hot summer for many!

© 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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