Rebuilding Financial Markets Confidence

By: Paul_J_Nolte

Headlines and the news programs were loaded with the dire news of over 500,000 newly unemployed and how the economy is headed into territory it has visited only once in our history. So why did the stock market rise by nearly 300 points by the trading days end? It might be that the 40% decline over the past year has already factored in much of the bad news already. As we have been discussing over the past two months, the economic data will be bad for at least the next couple of months as the credit collapse works its way through the economy. The coming week will hit a wide swath of the economic landscape, from housing to sentiment to inflation and trade.

While the Washington two-step with the auto industry is likely to garner much of the attention, the housing numbers may provide a glimmer of hope if, indeed, they can show some modest improvement (or at least not getting worse). Surprising to investors was the week ending rally in the face of a poor employment report. Could it be that the markets are beginning to sense an ending of the worst? It is still too early to tell – better would be some real live good data, but that may have to wait until well after the New Year party is over.

Still in a very wide trading range, the markets have now begin to coil – meaning the lows are higher and the highs are lower – forming a neat little triangle pointing to the future on a chart. Historically a break of this triangle signifies the new trend of the market that could last quite some time. In the present case, the betting is getting heavy on a break upward with an SP500 close over 900 (now 875).

A close below 815 would signal a continuation of the decline. One of our market models signaled a buying opportunity in late October, with the market less than a point higher than Friday. Since that time, interest rates have fallen through the floor and yields on the SP500 are now above those on the 30-year bond, an indication that investors are flocking to safety at all costs. Even a bear market rally could see the index rise 10-15% from here and still be within the context of a bear market. While we are not yet out of the woods, we are gaining more confidence that buying opportunities are at hand.

The bond market is now humming the limbo, with government bond rates out to two years below 1%, it seems hard to fathom that the 10-year bond can get much lower than the 2.7% it currently fetches. We are of the belief that over the next 10 years, stocks will handily surpass those returns and is one of the reasons for our gradual switch to stocks.

Our bond model still points to still lower rates, however any modest rise in short-term rates will move it to negative territory and likely be a signal that the bond bull market is over. We are still seeing some better yields in government agency bonds (the Freddie & Fannie bonds) and for those needing income that is getting increasing hard to get, this looks like a safe place to invest. IF (yes, in big letters) the equity markets can gain some strength we may look toward high yield bonds to provide both income and appreciation for fixed income investors.

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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