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NOLTE NOTES The fireworks in the sky across the nation had nothing on the fireworks on Wall Street last week, as continued takeover activity spurred stocks higher – even in the face of gathering storm clouds (energy prices and bond yields). The fireworks were also in the economic data, as employment gains continued to run faster than expectations and the ISM data from both manufacturers and services also showed economic strength. Many economists were busy reviewing their growth estimates for not only the second quarter, but also for the third, as the economy seems to be hitting on more cylinders than many expected. The expected impact from weaker housing (both in consumer confidence and sub-prime loan issues) seems to be minimal so far. And while it may flare in the future, today – in the words of Ben Bernanke – it is contained. For its part, the Fed has correctly stood on the sidelines watching the economy grow slowly with a very small dose of inflation the bond market has struggled with each new piece of data, either figuring a rate cut or increase into the next Fed meeting. Around the corner is earnings season and again investors will be focused upon company’s comments about the future – not so much of the past. The first earnings salvos begin this week – it should be a good show! For those that sold in May and went away – you haven’t missed much, as the markets are about where they were at the end of April. The volatility has picked up, as the daily moves are habitually around 100 points. The trading range that has existed over the past two months has been a boon to traders, however investors have been frustrated by the “treadmill” activity (running fast, but going nowhere). The market internals have been deteriorating for a while, however so far, the ultimate arbiter of breaking down – prices - has not done so yet. A break of the 1490 to 1540 range in the SP500 will determine the next direction for the markets, but most of the indicators so far are pointing to a break below 1490, with the next likely stop 1460, which markets the February peak and the top of the trading channel the SP500 has been contained within since 2004. The bottom of that channel is roughly 1325, a 12% correction that would, if reached by yearend, put the market at a 3% annualized gain for the past two years – well below bond returns. Earnings season will begin in two weeks, and outside of the energy complex, growth has been very hard to come by. We believe that more normal valuations are likely somewhere around the 1325 range discussed above. The stronger than expected economic figures once again put the bond market on the defensive and pushed rates back up toward 5.2%, after getting close to 5% less than two weeks ago. The bond model has been unfazed, remaining in negative territory for the past seven weeks. Short-term rates, after falling to nearly 4.5% a few weeks ago, have once again begun to rise – closing back in on 5%, a level that hasn’t been seen since the end of April. The yield curve has lost much of the inversion that has been the hallmark of this market for the past year – although at roughly a third of one percent, the curve is hardly “curved”. A normal curve is usually in the 125-170 basis point (hundredths of a percent) range. Keep an eye on both energy and the sub-prime “issue” as they could have opposite effects upon interest rates over the coming months.
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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