Stock Markets Trek to Higher Ground

By: Paul_J_Nolte

In a shout out to Kasey Kassem – keep your feet on the ground and reach for the sky! The equity markets continue the trek to higher ground last week, as the markets rose for 5 consecutive days before taking a breather on Friday. In what was a quiet week for economic data, the markets by rising most of the week are indicating that the path of least resistance remains higher. The coming week we’ll get to see the impact of “cash for clunkers” as retail sales will be released, along with inflation data and housing starts.

The bulk of economic data points to modest economic growth, although it is hard to quantify what impact the government stimulus packages are having, a growing concern is what will happen once the economy comes off “life-support”. The most recent releases of loan activity show that loans remain hard to get and across the economy loan activity is contracting. Without the “grease” that makes the economy engine go, we view trouble ahead once the stimulus ceases.

This week will mark the one-year anniversary of the Lehman Brothers bankruptcy and many have asked what has changed over the past year. Other than a lower market, very little seems to have changed, with the “too big to fail” policy still firmly in place (many are now bigger!), heavy government spending to induce an already spent consumer to spend some more and a growing sense that too much government intervention is not likely to be a good thing, whether on Wall Street or on healthcare. The lack of oversight on the banking side means that we will, at some point in the future, once again be held hostage to a financial crisis of even larger proportion.

Too many “special situations” and too little standards have gamed the system in favor of the few large institutions at the expense of the many smaller (and not too big to fail) institutions. Our analysis over the past six months has underestimated the effects of huge government spending and persistently low short-term interest rates. While we don’t think the economy can “drink itself sober”, the signs of sustainable economic recovery remain somewhere in the foggy future. Until then, the equity markets are likely to defy rational analysis.

Bond prices are on a tear, as bond yields on the 30-year bond got very close to getting under 3.1% last week. Bolstered by very good auctions on treasury issuances this week, investors have piled into bonds believing that foreign investors continue to support our borrowing habits. We tend to look at the bond market as the final arbiter of the state of the economy, as bonds began to rally late in 2007, well in advance of the general economic deterioration. We have been expecting yields to rise over the past few months to confirm the economic “green shoots” or the huge rally in gold (signaling inflationary fears). So far, short-term rates are near the lowest all year and the 30-year bond has closed at four month lows. The bond model still points to lower rates ahead, indicating the economic recovery is far from healthy.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2009 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - 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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