NOLTE NOTES
Inflation Fear
by Paul J. Nolte, CFA
May 12, 2008

Just as those long ago disc jockeys (when vinyl ruled the day) got disgusted with whatever they were playing would drag the needle across the record, jarring the listener who might actually like the song � today's financial markets may be jarring investors. Investors were getting used to Happy Days are Here Again playing on the radio, but then the scratch from both Citigroup and AIG forced investors to sit up and take note. While the economic data was a bit better, beneath the surface lurked issues that could once again take the markets back to the January lows. Retail sales improved, but primarily at the discount stores and much of that on higher fuel sales. The trade deficit narrowed � but here too we imported much less (slower economy) than we sent out. The coming week will provide additional color on the housing market as housing starts are released. Expectations are for a slight decline, but it has been noted in other places that the current inventory of unsold homes is twice the average inventory of the past 20 years. Since the housing problem remains, the financial trials and tribulations will also be around much longer � the needle skips on a scratch again and again and again.

The supposition that the markets could trade higher was dependant upon them staying above the top end of the trading range � that lasted for a few days. Many of our momentum indicators had already been stretched, however the long-term indicators are still rising. A likely result is that the markets take a break for a while, allowing the daily indicators to get back to �normal� and the long-term indicators do not get out of range. We have, however, highlighted one of the glaring issues with this market advance � lack of volume. In fact volume remains well below average levels for nearly any part of the year, so any advance, let alone any break above the year long trading range should be met with skepticism � and why we put little emphasis on the breaking of the trading range. Obviously the focus by investors on the energy and commodity markets has boosted those groups well ahead of the rest of the markets and they should, at some point, come back to the troops � the key questions is when and from what level. For now, the markets are once again entrenched in a broad trading range that could see another test of the lows � which reside nearly 10% below Friday's close. Until conviction begins to enter the markets in the form of higher volume we are expecting little in the way of either an advance or decline.

As any serious student of the market or economist if energy prices were to double in a year, what would be happening to interest rates? The likely answer is that they would be skyrocketing. Today, that would be far off of reality. In fact long bond rates have fallen by a quarter and short rates by three full percentage points. The key to the �inflation fear� is not merely higher energy/food prices, but wage pressures, which are actually receding. Since wages are not rising at an ever-faster rate, it will be very hard for consumers to actually pay for the higher prices, meaning they will be cutting back on overall spending. The rebate notwithstanding, we see a very long period of consumer retrenchment and restrained spending which should keep interest rates relatively contained.

© 2008 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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