Strong Stock Markets as the Government Comes to the Rescue!

By: Paul_J_Nolte

The government to the rescue! Early last week, it looked as though we would get serious about going lower, and then came a cash infusion for Citigroup and this week, the President announced a “bailout” for some homeowners – as long as you fit into the relatively narrow criterion. Stock investors, especially those in the housing/financing related issues took flight, rising by at least 10% over the past two weeks. The economy supported some of the move, as recessionary fears moved to the back burner.

Two key reports this week – the ISM report on manufacturing and services indicated a slowing in the economy, but not yet ready to roll into a recession. Employment gains were a bit better than expected, however after revisions, growth in employment remains well below that of just a year ago and the trend continued lower. Also of concern, wage growth over the past twelve months as begun to decline from over 4% to around 3.5% - not a good sign for those looking for a good Christmas selling season. This week we see if we get a glimpse at our trade picture, which has been improving, thanks to a combination of the lower dollar and slower spending here. 

In keeping with the seasonally strong markets, stocks continued to rise, closing above the psychologically important 200-day moving average of prices. This has opened the door for stocks to make another attempt at the old highs (about 3% from here), which would be in keeping with the favorable December markets. As usual, there are flies in the ointment. First, the number of stocks that are participating in this rally are fewer than the late summer rally, which were less than those in the spring rally. At some point, the lack of overall participation will lead to another round of selling. We are seeing a shift in momentum toward generally lower prices in the future.

With all the Fed has done over the past three months (cutting rates, additional liquidity, etc) the markets are only slightly higher – so the expectations that the Fed likely cut on Tuesday will provide anything more than a temporary boost to prices may be as misguided as they were during the last interest rate cutting cycle during 2000-02. Valuations remain elevated and expectations are also much closer to the highs than lows – not a recipe for a new bull market. More than likely the markets will continue within their wide trading range of the past 7 months.

The bond markets took a step back as the economic data was better than expected, so the Fed is not likely to cut as much as first thought. The bond market continues its pattern of acting better when the news is worst, and worse when the news is good. Our industry group work (outlined below) is showing that many of the basic material groups performing better, an indication that investors believe any economic slowdown will be mild and shallow. While it remains to be determined how deep any recession may go, the bond market is stuck between a general economic slowing and higher commodity prices (hence the reason for better basic material stocks). Despite the short-term rise in rates, our models point to still lower yields in the future.

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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