NOLTE NOTES
Inflation Remains a Concern
by Paul J. Nolte, CFA
August 25, 2008

The market’s eyes, dimmed by the strong sun at the beach, begins to look at the political landscape this week as the Democratic convention kicks off in Denver. The Republicans convene next week in Minneapolis and both will begin flooding the airwaves and print publications with their positions and what they would do if elected. The economy and any programs to aid the ailing patient are likely to be put WAY back on the top shelf until sometime early next year once the new administration takes office. Back in the real world, the housing/financial crisis continue to grab the business headlines, as Lehman is a rumored buyout candidate, some banks declare themselves solvent and in need of no additional dollars to survive. Inflation remains a concern, as the producer price index came is well above expectations. However the spread between costs going into production and prices charged at retail continue to widen, putting additional pressure on corporate earnings. The coming week will get additional housing data, from new and existing home sales to home prices. The decline in home prices will keep the pressure on financial companies – necessitating the need to raise additional capital as more assets get written off – keeping pressure on home prices. A cycle that won’t be broken be either candidate’s election.

With trading volumes now near those of the Christmas/New Year’s holiday lows, it is hard to put much of a technical analysis of the markets, as many of our indicators have barely budged over the past two weeks. One noteworthy item however, has been the number of stocks going up vs. those going down. Over the past five weeks that the markets rallied (twice up over 390 points), the number of gaining stocks was barely ahead of those falling in price. Last week the number of declining stocks (for a market down about half a percent) was greater than those rising in any of the prior five week – on other words, the selling was more across the board than the buying had been. In fact if the total number of gaining stocks were compared to the total declining over the past five weeks, it would be even – this as the stock market is actually higher by roughly 3%. If the markets are not supported by the “troops”, then the entire move has to be questioned for sustainability. Unless traders get back from the beach soon, they may get burned in more ways than one!

After three weeks of declining yields, our bond model has flipped to the sell side, indicating that yields are expected to rise in the weeks ahead. While we don’t put a heavy weight on just one week, we are definitely in a trading range for bond yields – between 4.4% and 5.3% on the long bond that has persisted since mid-’02. Short-term rates over that same period have gone from under 2% to just over 5% and back under 2%. The violent moves in short-term bonds makes nearly impossible to time the bond market and as a result we have adopted a relatively passive approach, buying longer term bonds as yields get close to 5% and shorter as they approach 4.5%. It hasn’t been exciting, but bond investing isn’t supposed to be, as we get our kicks from stocks. For some time we have advised clients to ladder bonds over a 5-10 year period and little in today’s markets indicate we should deviate from that approach.

© 2008 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.

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