Nolte Notes - What if ? Trade War with China ?, War with Iran ? Still expect lower US interest rates

By: Paul_J_Nolte

Former Speaker of the House, Tip O'Neil said that all politics is local. However, today the focus is trained upon everywhere but within our boarders. The hostage “situation” in Iran, the rumblings of protection legislation directed at China as well as the ongoing debate about the war in Iraq. What we need is a good debate about a new stop light in the middle of town! The impact upon the financial markets has been to take their eyes off the economy and play many “what-if” games – what if the hostage crisis lingers in Iran, what will be the impact upon our oil supply.

What if Congress is successful in passing restrictive trade (or sanctions) against China – will the President veto? (Very likely) If we allow our eyes to refocus upon the US economy, the housing debate continues to rage, has the sub-prime problem been contained (signs point to no)? Has housing stabilized? (Jury still out) And to top it all off, earnings season will be starting in a couple of weeks. The coming week will be all about the economy, as the purchasing managers index is due Monday, factory orders Wednesday and the very important employment report on Friday. Oil and the global news will impact this week in between these reports, but we should have a good sense of economic strength by next weekend.

We got what we were looking for when we last put fingers to keyboard – a rally back to near the old highs – but as we suspected, it came on tepid volume and marginally more advancing than declining stocks. Like a roller coaster – the first quarter ended about where it started, with some nice rises and hair raising drops. For the first time in over three years, our quarterly indicator, which looks at dividend yields and treasury yields has moved one step toward positive, as yields on treasury bills are actually only 9% higher than a year ago (well down from the 100% of a year ago).

Dividend yields remain very low, so the all clear is not close to a positive signal. Other indicators we use still point to lower prices ahead – a still high market multiple that will get some adjustment as we go through earnings season. Our longer-term weekly indicators still are moving lower and are at least 6-12 weeks away from bottoming (if current trends hold) and our daily data is confirming the weakness of the current rally. So, while the markets may head higher over the short-term, we believe the likeliest path is lower into the late spring.

Our bond model continues to point to lower interest rates ahead, however we are getting more concerned that rates may continue to move higher in the short-term, given the higher inflation reports of the past week and a potentially strong employment report (at least on headlines) on Friday. In addition, our model of non-correlated asset classes is showing better performance from the commodity complex, after doing poorly since Thanksgiving. Finally, much has been made of the yield curve over the past week, as now yields on two and ten year bonds are now normal (two's less than ten's), however most other points along the curve remain inverted – especially with the year and under maturities. 

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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