Financial Markets in the Middle of a Hurricane of Tornado?

By: Paul_J_Nolte

A nice little treat at the end of October as the markets managed a weekly gain for only the third time since the end of August. The question remains as to whether we are in the middle of a hurricane or tornado. The difference? We could be in the eye of the hurricane, with more destruction ahead or the tornado has already plowed through and the slow rebuilding process can begin.

Our best guess is that that from an economic perspective, we are in a hurricane, as the economic data will continue to be bad over at least the next two quarters. Employment is likely to average losses of nearly 200k by the time we get to the first quarter, GDP is going to be more negative than the relatively benign loss of 0.3% recently reported and overall consumer spending will continue to show less spending and more savings.

What about the markets? Here the damage has likely been done and the slow rebuilding process is beginning. That doesn't mean that it will always be sunshiny, as a few storms can still blow through Wall Street, however we still believe we are in the process of making a bottom that will likely take a few more months to complete with broad daily swings and worries about economic health. The key point is that any recovery, economic or market will be slow and gradual with many false turns – but it is beginning.

The harsh declines in the markets are keeping many of our indicators in deeply oversold territory. Even a 900-point Dow rally has done little to improve the situation. At this point we are separating ourselves from the technical picture to make investment decisions and relying more heavily upon the fundamentals of the overall market, which indicate we are in a buying zone. Whether the markets fall further (very possible) or we have seen the lows (Oct 10 and tested again on 10/27), the markets look cheap to us and should provide above average returns over the next few years.

The poor economic data and likely still punk earnings reports are likely to be able to provide additional buying opportunities over the next few months to increase equity weights to more normal levels. Unfortunately the technical picture fails during these types of declines – as they show an oversold market that continues to fall instead of one that should rally once an oversold level is reached.

Another cut by the Fed, down to 1% and in conjunction with central banks around the world, interest rates are falling in an effort to “force” investors and companies alike to put the mound of cash to better use than sitting in short-term investments. The bond model, surprisingly, has been negative for the past three weeks. Interestingly, both short and long-term rates are slightly higher since the signal change. A concern among investors is the inflationary implications of the huge “dump” of money into the financial system.

Over time, that certainly may be the case, however more immediately deflation is the primary concern – with prices for many goods falling, from homes to energy to food. Pump prices nationwide are now lower than a year ago, something that will be showing up in the inflation numbers reported later this month. We won't yet, but soon be investing in bonds that protected from inflation (TIPS).

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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