NOLTE NOTES
Trouble in Europe
by Paul J. Nolte, CFA
May 31, 2010

If only this were Las Vegas: what is going on in Europe stays in Europe. However this has been a global economy for many years, and the ripple leaving their shores is becoming a tsunami on our shores. Whether Greece, the downgrade to Spain’s debt or the likelihood of additional problems with other countries in southern Europe, investors saw the global equity markets take their largest step back since the March ’09 bottom and worries have begun to surface that default is becoming closer to reality than many suspected just a month ago. While the economic data here continues to look “ok”, it has not been enough to turn investor’s heads toward the domestic economy. The coming week will see the unemployment release, where estimates for over 500,000 in new jobs are expected. Risks may be short of that number, as the weekly jobless claims can’t seem to get below 400,000, which would indicate real growth in the labor market. The economic recovery here is real, albeit extremely slow and still prone to external shocks. A good employment report may snap the markets from their malaise, but one significantly below expectations could spell trouble both for the economy and financial markets.

While the markets fret over the latest problem in Europe, ever so slowly it seems as though buying stocks may be the best thing to do. I highlighted last week the extremely oversold condition of the markets, with net advancing stocks putting in their worst performance since the March ’09 bottom has now been joined by very poor sentiment. Why is this good? Sentiment reflects what investors have done, if investors are in despair, they have already sold their holdings and are looking for even lower prices to buy. However, if “everyone” has already sold, the next decision is when/what to purchase. Conversely, when investors are bullish, their portfolios are loaded with stocks and the next decision is what/when to sell. Individual investors (as measured by AAII) have turned significantly negative over the past two weeks. The net difference between bulls and bears in their survey is a negative 21; surpassed by a mini-bottom in Nov. ’09 and the March ’09 bottom. I would like to see investment advisors turn more negative, as their survey is still modestly bullish. Given the huge amount of selling over the past five weeks, a relief rally of more than a day or two is expected, how strong and how high will be determined by the strength of the economic data this week.

Bonds acted as the calm parent to the impetuous children of the equity markets, finishing relatively unchanged on the week. The model continues to point to lower yields ahead, but given the huge run in bonds, it would not be a surprise to see yields go higher while the equity markets regain some footing and trade better over the next couple of weeks. Commodity prices are up less than 10% vs. a year ago levels, well down from their yr/yr peak of over 40% at yearend. This may be the best opportunity to shorten up duration/maturities as yields may rise (even with the positive model) a bit as (hopefully) the global markets settle for a few weeks.

© 2010 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.

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Paul J. Nolte, CFA | Managing Director, Dearborn Partners
Chicago, Illinois | (312) 334-7123 Tel | Email | Website