The "Real" US Economy

By: Paul_J_Nolte

Everything was looking good until Friday. Instead of bringing good things to light, they turned out the lights on the nascent market rally and put everyone back on their heels. The GE report came after the government reported the trade deficit worsened the day before – without much fanfare. However, in our view the worsening trade deficit takes out one of the few remaining legs supporting the large multi-national companies, specifically that while domestic sales are down, the foreign sales should carry the day.

Thursday saw Wal-Mart report better than expected earnings (likely from higher priced gas sales) and increased their estimates. Below the surface, this actually supports our views that the consumer is weak and shopping where they get the best deals – not at the upscale stores, but the “bread & butter” basics supplied by Wal-Mart. Earnings season gets into full swing over the next three weeks and investors will get a better idea of whether the economy is coming or going. The financials will be watched closely, especially following the news of the past few weeks of capital infusions at a variety of institutions. Also in focus this coming week will be inflation reports, combined with higher energy and commodity prices, questions are sure to fly about their relevance in measuring the “real” economy.

Many of our market indicators actually improved on the week, even as stocks declined on Friday and falling for the week. We have begun to highlight the volume figures – while not ideal (still low), they have been showing improvement on advancing days and retreating with the market declines. Many of our weekly indicators are at very low levels that have also, historically, been at turning points for the markets. While these give us some hope that the markets will finally break their narrow trading range between 1272 and 1400 on the SP500. The very short up trend that began with the recent bottom in March has been broken and another 3% decline to 1300 could be expected. A serious break of 1300 could open the way for yet another test of the yearly lows at 1265 – and below that would be 1225.

We will be watching the markets for signs that we could be at a meaningful bottom that will allow us to step into the markets more comfortably. One negative that could yet come into play is the valuations on the markets. Today, the SP500 is priced at roughly 20 times (declining) earnings. Before the markets begin to look cheap, the SP500 would have to decline to below 1200 – and more likely below 1100 before we could declare prices are cheap and worth buying for more than a couple of months.

The bond market was looking a bit sick until the Friday decline, finishing unchanged on the week. Even in the face of still rising commodity prices, bonds have been the safe haven investment in a tumultuous market. The difference between the high quality treasury bonds and below investment grade (or junk) bonds (called the spread) is nearly 3½ percentage points, the third highest in over 45 years. While we are tempted to begin buying funds that participate in this market, we would rather see the spreads begin to decline before we get interested. In 1982, it took nine months to collapse the spread from 4 percentage points to just under 2. In 2002, it took three years. What should be noted is that these peaks also correlated well with bottoms in equity prices – something as yet unconfirmed.

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

Copyright © 2008 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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