NOLTE NOTES
Changing Market Complexion
by Paul J. Nolte, CFA
April 18, 2005

Thank God for the weekend! At least we have a couple of days where the markets won't be falling out of bed. As investor�s sentiment changed from worrying about interest rate increases to a slowing economy and just maybe a recession looming on the horizon, the equity markets adjusted � quickly. So what is going on? Among the economic releases and their implications may provide a bit of a clue. First, retail sales came in below expectations, as oil prices may be taking a bite out of consumers. Second, the trade figures continued to deteriorate, however more importantly, we are exporting into even weaker economies (foreign growth is below that of the U.S.). Finally, the ever-ebullient consumer may be rethinking their position, as confidence also declined in March. With so much cheer going around, it is little wonder that the markets are beginning to reconsider a 50 basis point increase in Fed rates and just how many more �measured� rate hikes are in our future. Taking a look at the groups, it is very evident that money flowed out of energy and basic material stocks and into consumer and healthcare issues � a normal �conservative� trade and along with other developments outlined below, a change in the complexion of the market may be at hand. The coming week investor�s focus will be on earnings announcements, as we enter the �fat� portion of earnings season. The economic focus will be on inflation as both consumer and producer prices are released. It will be interesting to see what effect oil prices will have in these two figures.

More than the NYSE, the OTC really took it on the chin last week. From the perspective of advancing to declining issues, there have only been two worse weeks in the past five years (just after 9/11 and just after the peak in �00). Could we be seeing the beginning of the end of the bull market? With last week�s action in the bag, we calculated our cross-market indicators and small cap stocks have crossed below large cap stocks in relative performance for only the second time since the beginning of their bull market in 2000. What leads us to put more weight on this crossing than in �03 is the comparative valuations of small stocks is now as high as it has been in over 20 years. We are also VERY concerned that bonds have crossed above the relative performance line vs. the SP500, an indication that we should be reducing our equity exposure. Since we believe we may be toward the end of the interest rate hike cycle, we should pay heed to this change as well. While we expect some semblance of a bounce next week, we may be using any strength to reposition portfolios appropriately.

The bond model has moved back to negative territory with a reading of �2� as utility stocks declined below their �positive� line. However, the declining CRB index (over fears of a slowing economy that won't need as much raw materials) could move the indicator back to positive territory next week. We have been waiting for bonds to approach the 5% level (now at 4.75%) as a trigger point to begin loading up on fixed income and pushing out maturities. The declining equity markets may mean that investors pile into bonds ahead of the 5% level, so we will be reviewing our bond positions as well, anticipating that we may begin lengthening maturities, anticipating that rates could be flat to falling between today and yearend.

© 2005 Paul J. Nolte, CFA
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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.

Contact Information
Paul J. Nolte, CFA
Director Investments
Hinsdale Associates
630-325-7100
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