All the king's horses
by Paul J. Nolte, CFA
January 22, 2008
All the king�s horses and all the king�s men couldn�t put Humpty Dumpty back together again. So was the story with the stock market and President Bush�s as well as Ben Bernanke�s response to the economic cry heard around the world. The US markets reacted poorly to the economic data (housing starts well down, consumer confidence also lower) as well as the continued increases in write-offs within the banking industry related to their loan book. The housing related data is not getting worse, however it remains at/near all-time lows. Whether the government�s plan is to toss a few bucks our way or to crowbar open the loan process, we are not likely to see real benefits in the economy until early summer- at best. The coming week brings little in the way of economic news (but what news � existing home sales), however a boatload of earnings reports could sway investors. It will be interesting to hear how the credit crunch and slowing consumer spending is having an effect on businesses from industrial to technology and to retail. Obviously we are closer to a bottom than a top, however all the jawboning last week left investors wanting more � last chance for a preemptive rate cut by the Fed!
Our comments from last week were meant to play out over a few weeks or months, not a few days. To quote Paul Simon (musician, not politician) � one man�s ceiling is another man�s floor. The 1370 level did provide a floor for stock prices twice over the past year. Now, we are looking at the �ceiling� of May �06 to provide a floor for prices. If successful (fingers crossed!), the 1370 area may be a future ceiling that will be difficult to overcome. The market internals continue to show weakness, however a glimmer of hope comes from the volume figures. Although this week was rough, volume has been improving some on rallies vs. declines since the November bottom (when the SP500 was 1425, not 1325) and save for option expiration Friday, volume remains well below the August selling climax. What does concern us is that �fear� as measured by the volatility index (or VIX) remains well below those prior markets bottoms � in other words, not enough fear to create a meaningful bottom. Finally, the valuation of the market is looking better, as the PE based upon recent peak earnings is now among the lowest since 1992 � although still not down to the 11-12 bottoms seen in the early 70s.
The decline in bond yields has kept our models in positive territory � pointing to still lower yields ahead, however, even with another cut by the Fed looming in the next few weeks, much of the decline would need to be at the shorter end of the curve, as long bond rates are now approaching the lows made during the last huge rate decline. The yield curve has moved to a 100 basis point spread (between short and long-term rates) and while not yet to normal ranges, it is an improvement and will allow banks to begin shoring up balance sheets. One overriding concern with bonds is the persistently high commodity prices, which remain 20% higher than a year ago.
© 2008 Paul J. Nolte, CFA
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.
Paul J. Nolte, CFA