NOLTE NOTES - Stock Market Rally - Where's the Volume?

By: Paul_J_Nolte

Imagine watching your favorite football team on a Sunday afternoon and hearing the following from the announcers: “without any penalty flags, the (your team!) will be starting at the 50 yard line instead of inside the 5 where the ball was whistled dead”. You'd be turning up the volume way high to figure out what just happened. The economic figures on employment could be viewed the same way – after indicating the economy lost jobs last month, this month showed a gain AND the prior to months were revised to show decent gains – with little explanation.

We doubt the interest rate cut of two weeks ago would work THAT fast! Also hard to fathom were the announcements from the brokerage/banking community about huge losses related to sub-prime mortgages that the stock market just loved (and actually rose by nearly 200 points). The last few weeks we may have passed through the looking glass, where nothing is quite as it seems. This week brings the beginnings of the earnings season. While the Street may be discounting anything from the financial sector, keep your eyes on what companies have to say about both the domestic and foreign economies – it may be sobering.

New all-time highs on the Dow – but it came without the fanfare of the last time it closed over 14k (just before the gut wrenching decline). In fact, few companies are actually participating in this new ascent, as less than 300 new highs have been made over the past week, while three times in early July the new high list expanded that far. Volume for this rise has been notably missing and investor concerns have melted away as Investor's Intelligence is reporting the second highest “bullish percentage” this year. But as many investors remember lessons of the late ‘90s, the markets can act irrational much longer than anyone betting against it can remain liquid.

So while the markets continue their head scratching rise to the heavens, we believe that the Dow will be hard pressed to be higher than today a year from now. The assumptions that we believe are being made in the market today include earnings will continue to grow at (or near) double-digit rates, while margins also expand from their record highs. Still lingering in the background is the housing market – or maybe it was dealt with neatly in a four-week period and all is once again right with the world of high finance.

The bond model has a slippery grip on a positive reading (still at “3”), as short rates have dropped and corporate bond performance has improved. This week brings inflation data that should show that inflation remains “contained”, however we are watching the commodity index, which has been modestly higher over the past twelve months….until this month, when it has shot up over 20% vs. its year ago levels.

A year ago we saw both the energy and gold complexes decline in price in the early fall as summer driving season ended and gold was still in the process of correcting the 2005 rise. Today, although pump prices have declined some, they have not fallen as much as last year and gold remains strong, especially in the face of the weakening dollar. Last week we discussed the agricultural commodities as still rising, so while the inflation report this week might be market friendly, the future may not be as accommodating.

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

Copyright © 2007 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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