Anticipated Stock Market Correction on Not So Hot Bank Earnings and Economic Data

By: Paul_J_Nolte

We may have gotten our answer posed last week with the thud heard on Wall Street this week; earnings at the banks are not that great and neither is the economic data, giving the equity markets a bad case of the flu! Housing continues in a funk, with starts declining (again), although those looking at the glass half full would say that permits (a leading indicator) rose – potentially providing some good news in the months ahead. Also jumping a bit were initial jobless claims, and more importantly the rise above its 10-week average, potentially ending talk of job gains come the February jobs report.

Evidence of job losses showed up in a report from the states showing job losses in 44 of the 50 states. Elsewhere in the world, China may be putting a brake on their economic growth by raising interest rates (which may be the culprit behind the market decline) and President Obama, after handing out billions in financial aid to the banking system started talking tough about regulation. Did last week serve notice that the equity markets are undergoing a serious change or merely a correction? We’re betting on the former than the latter.

The equity markets finished the week on a very sour note, with both the NYSE and OTC markets registering 1000 more declining issues than advancing for three consecutive days, which has not been seen since late February 2009, just as the mighty bear market finished its feeding frenzy. What makes this decline significant are the breaking of the up trend line since the March bottom, increased volume as the markets declined and a significant break of the 50-day moving average. We fully expect a market rally early in the week the character of that advance should determine whether the decline of last week was the beginning of the much anticipated “correction” that is supposed to take the markets down 10% or so.

With half already in the bag and investor sentiment still very high, we expect that over the coming weeks, we could easily see another 5% shaved from the averages as investors fret about a variety of economic ills, new financial legislation or poor earnings data. The increase in volume during much of the decline indicates that investors are very willing to sell holdings quickly, rather than wait for further economic or company data.  If the rally does come early in the week and does on rather anemic volume, we may be tempted to reduce our equity exposure some during the week.

The bond model remains in bullish territory at “3”, indicating the likely direction of interest rates over the coming weeks is down. The weak economic data as well as declining equity prices kept the treasury market bid rather strong as investors begin to reallocate some funds to bonds from equities. While the line is not direct from weak equities to strong bonds, bonds are one of the only low correlated asset classes with equities at this time.

We saw correlations rise during the ’06-’07 market advance and they stayed high during the decline. Although bonds are yielding very little at this point, they do provide some certainty about the return OF capital at the end of a period of time as well as (at least) a small income component.

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

Copyright © 2010 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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