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NOLTE NOTES Good time to take a vacation and clear the mind and body of all things Wall Street. However, upon return the markets are acting as though the financial world is ending. While we have been concerned about the markets for much of this year (our beginning year prediction was for a flat return at best), the near seizing up of portions of the credit markets was alleviated by the Fed cutting the discount rate by a half of one percent on Friday before the market open. The Fed has been involved in providing liquidity to the markets over the past few weeks, however the cut was a more formal statement that they stand at the ready to provide the “grease” to keep the economic wheels moving. The very sensitive markets have seen volatility return with a vengeance as Thursday’s nearly unchanged reading came with the markets traveling over 1100 points to get there. We had expected a violent rally to take place at some point this week and will be using any market strength to lighten positions instead of trying to buy the market dips, as we believe the stock market is not yet done punishing investors holding risky positions. Whatever continued rally occurs is likely to push the markets up 3-5%, however there will come a point that the lows of last week are revisited – it will be the test to determine whether the markets fail or succeed in continuing their four year run to higher ground. The wild daily swings have been a boon to those that are able to nimbly trade the markets, however for long-term investors the end result of two weeks of wildness is actually a net gain in the SP500 of nearly 1% - masking the real damage to many stocks. Over the past five weeks, advancing stocks have lost out to declining stocks and new weekly highs have shrunk to their smallest number in over a year, while the new weekly lows have expanded to their highest levels in 9 years. While our daily reading point to a rally, the longer-term weekly data is not yet to the point that would argue for a long-term bottom as it did in 2002. So we expect the market to flop around as a fish out of water, but trend lower through the remainder of the quarter. Over the past three months the large cap growth portion of portfolios has performed the best, while losing less money than other categories. We are entering a period where relative returns are less meaningful (I still lost money!) and absolute returns become important (just make me something!). As investors begin to realize that the current storm is merely a category one or two hurricane and that worse could be brewing on the horizon. The decline in short rates (as the markets anticipate a rate cut) and commodity prices (as investors sell prior winners to cover losses) pushed our interest rate model to a positive reading for the first time in 12 weeks. In what has been a flight to quality from anything risky, we are not putting a lot of credence in the recent change in the model as a lasting long-term change. While we do believe the Fed will cut rates at least once this year, a full-blown recession is not yet in the cards to force interest rates significantly lower from here. The decline in yield on short maturities has created a positive slope from short to long, however it is not at all smooth and looks more like a mountain range than a playground slide. The big question is whether foreign investors will continue to pour money into the debt ridden US economy.
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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