NOLTE NOTES
Goldman Sachs Fraud Aftermath
by Paul J. Nolte, CFA
April 19, 2010

WorldCom, Enron, Bear Stearns and Arthur Anderson – just but a few names that once lit up the Wall Street sky that are no more. While still way too early to declare it a has-been, the SEC suit against Goldman Sachs for fraud is now the poster child for all that is wrong on Wall Street and led to Friday’s 100+ point decline. The question investors focused upon in the aftermath of the revelations is this the next shoe to drop in the financial meltdown? For some, this is gasoline tossed on the smoldering fire of regulation proposed by Sen. Dodd last month, but will the ensuing fire burn investors anew? All the financial machinations cast a pall over what had been a decent start to earnings season, with over 70% of those reporting beat estimates for both earnings and revenue. The economic numbers reported remained uneven as unemployment claims remain high, however a modest increase in new home construction gave some hope for real estate. Goldman is likely to remain center stage for at least the next couple of weeks, stealing the show from earnings and the economy, as Greece did early in January. It remains to be seen if this develops into more than just a modest 5-7% correction.

As mentioned above, Friday’s sell-off could be the beginning phase of a correction in the market that is well overdue. The major question is whether the correction morphs into something more significant or just another minor correction similar to the many seen since the March ’09 bottom that give investors a very small window to get into the relentless rising market. At this point, given the strength in the advance decline line (net number of stocks rising vs. falling) points to underlying strength that should allow the markets to weather the current blow. Unlike the ’07-’08 period, where the majority of stocks were declining well ahead of the markets, the close on Thursday put the net advance line at a new all-time high. If we were to draw-up our expected market outcome over the next couple of months, it would look as follows: a 5-10% correction that lasts into June, a summer rally that takes the markets through the recent highs before finally rolling over early in the fall. While the economy is recovering (especially the manufacturing sector), it remains very uncertain as to the real impact of government spending upon the health of the economy. Once removed, will the economy (and markets) rollover?

The bond model is now at a 5 out of 5, the strongest reading possible. While not significantly better than a 3 of 5 (the point between rising/falling rates), it does indicate that bond yields are falling, utility stocks are rising and commodity prices are generally falling. Since the bond model flipped positive a month ago, long-term bond yields have remained unchanged at roughly 4.65%, which is where they were at last Christmas. Given the concerns over huge government debt levels with all the potential inflation pressures for the future, bond yields on the long side have remained within a tenth of a percent on either side of that 4.65% figure (on a weekly close basis). We would be concerned if rates spiked over 5% this summer.

© 2010 Paul J. Nolte, CFA
Editorial Archive

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 | Managing Director, Dearborn Partners
Chicago, Illinois | (312) 334-7123 Tel | Email | Website