NOLTE NOTES
Where the Bear, There the Bear
by Paul J. Nolte, CFA
July 7, 2008

With profuse apologies to Mel Brooks – where (the) bear, there (the) bear. After much hand wringing, the bear market “officially” began this week as the major averages have declined by 20% from their peak levels of last October. Energy and food prices continue to rise, jobs continue to be “lost” and the banking system is still looking for fresh money – is it little wonder that the consumer is a bit down in the mouth? Fearing additional inflationary hits, the European banks raised their rates by a quarter percent, leaving many to wonder anew why the Fed didn’t raise rates in the prior weeks. The big economic report last week was employment – and a couple of facts about the figures. First, while the number of jobs lost “hit” estimates, the amount of prior month revisions (lower) meant over 100k in jobs were lost between reports. Wages still are rising at modest levels: without big wage increases, consumers are falling further behind rising prices. Finally, in a sign jobs are hard to get, median duration of unemployment shot up to 10 weeks from just above 8 (highest level in 4 years). So what’s next? Earnings season begins next week and we should get solid information from corporations about the health of their respective businesses. Walk this way…no, no, THIS way – and we’ll explore.

So we are in a bear market, now what? In a cover story from Barron’s, a review of past bears indicate that we have another year before it is over and anywhere between another 9 to (ugh!) 30% to go before all is clear to invest again. Our own models show that the markets are beginning to get into cheap territory, however the markets rarely stop at just cheap or expensive. We estimate that the SP500 could dip below 1200 to enter the cheap zone. However if the markets visit “really cheap” levels that haven’t been seen since the last really big bear of ’73-74, then the risks are for a complete erasure of the gains from ’03. At the SP500 low of 815, the markets would be selling for less than 10x likely peak earnings and would project returns, at that point, of 15% annually for the next 10 years. With earnings down already nearly 30% from year ago levels, and a market down “only” 20%, we should see another 10% decline in stocks over the rest of the year. A rally can still occur in the next week or two, but it should be used to lighten equity holdings and not used as a buying opportunity.
 
The excitement we had for bonds last week was dashed this week as higher European rates and persistently higher commodity prices kept bonds from rallying on otherwise weak economic data. Bonds were to provide a good offset to lower equity prices this year, however with 10-year bonds up a bit in yield (and lower in price) the only real returns gained from bond holdings have been those under 3 year maturities (rates fell from just over 3 to under 2%). Unless and until the bond market begins to worry more about economic growth than inflation, bond yields will remain persistently higher than we otherwise think they should. Mortgage rates should be the key metric to watch – once mortgage rates begin to drop, we will have some confirmation that the financial sector is healthy enough to begin lending and providing some grease for the economic wheels.

© 2008 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.

CONTACT INFORMATION
Paul J. Nolte, CFA
Director Investments
Hinsdale Associates
630-325-7100
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