Like the Roman god, Janus, the markets are looking both forwards and backwards – hence the reluctance to put on a big show and rally strongly to new highs. Also, a reason for the swoon mid-week as the Fed indicated that they remain concerned about inflation and that rates may still be increased in the future. Many would believe that inflation figures are backward looking and that the Fed should be more concerned with housing and the issues surrounding the sub-prime loan market (a forward looking item), the reported inflation figures from the producers indicated that inflation remains relatively tame. Spurred by a good start to the earnings season, stocks generally rose as investors hoped companies have talked down their earnings to such a low level that even a snake could hurdle “expectations”.

The markets tend to be a bit twitchy and their focus doesn't remain on one item for too long – hence their concern regarding the currencies. The dollar has been declining for and is approaching the lows against the major currencies that have provided a good bounce on three separate occasions in the past. Combined with trade war rumblings with China, the US dollar may become the next “big thing” that is the cause for the markets rise or fall in the weeks ahead. We will try to emulate Janus – looking at the earnings of the quarter just past, but watching for signs that the economy is not what everyone expects.

What correction? With last week's rise, many of the markets are back to within a day or two of the yearly highs and with the promise of better than expected earnings, the markets are once again racing higher. But racing might be a bit strong, if we look at volume as the speed at which everyone is willing to buy stocks. Wednesday's decline of 90 Dow points was on volume that hasn't been seen since the beginning of the bounce on three weeks ago. If we look at a rolling 29 trading day period, down volume has swamped up volume consistently since early March, even though there have been 10 more days of market advances than declines.

So what is happening is the market rises, but on little volume, but declines occur on heavier volume – to us an indication that investors are more willing sellers than buyers. Our daily data is once again knocking on the door of being in dangerously high territory and any missteps in the earnings season could put the market in a defensive posture. Even though our weekly, longer-term data has turned up, it has done so from very uncharacteristically high levels – a sign that investors have “learned” to buy the declines as the market “always” will go up – until it no longer does.

The “house of bonds” failed to get blown over by the triple threat of trade (the dollar), Fed comments and the producer price report. The bond model remains at a positive “3” reading with the yield curve still flattening, indicating the economy may be picking up steam. The housing market is generally very interest rate sensitive, as rates fall, housing improves – however the correlation between interest rates and housing is beginning to unravel – meaning lower rates are not spurring activity. It has been our contention that rates will not solve the excess inventory in housing, that only a prolonged decline in prices will “fix” housing. Keep an eye on the housing affordability index as an indicator of a healthier environment.

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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