Overbought Stock Market Being Evaluated

By: Paul_J_Nolte

Will the cure be worse than the disease? Good news was everywhere last week, as housing looks to be turning, consumers did well with the cash for clunkers program and confidence is high (even though incomes failed to rise). Unfortunately the equity markets remained subdued while bond yields fell. The coming week is the usual beginning of the month heavyweights of employment and data from supply management reports on manufacturing and services.

Estimates for employment are a slight rise with payrolls shrinking by an ever-smaller amount. While the weekly unemployment claims figures indicate payroll losses in the 300k range, the markets are expecting just over 225k. So what is the cost of the good news? According to the White House, another $2billion on top of an already huge budget deficit of $7billion over the next 10 years. If the past is any indication, these numbers are certain to rise further as the assumptions are always much rosier than reality. Maybe a shot of whiskey would have been better.

In the kitchen a watched pot never boils, in the financial markets high expectations for an event never happen. Witness the “head and shoulders” top that was supposed to push to markets lower during the summer. Discussed nearly everywhere, the initial break lower was a fake-out and the markets promptly surged to new yearly highs.

Today, the discussion is about the terrible Sept/Oct period. Historically the August to Halloween periods are the worst in the financial calendar, with September averaging over a 1% loss over the past 80+ years. Drawing up a “maybe” scenario would be a market that slogs through the dangerous period with minimal gains/losses and then finally correct toward yearend as many of the government programs end and the consumer remains in hibernation mode as winter begins. The number of advancing to declining stocks over the past four months has been strong and not indicative of a market that is ready to rollover. There are many issues with the markets today, from too bullish investor sentiment to an “overbought” market that is setting up for failure. Unless the economic data is well below expectations the only fall over the next two months will be in nature and not on Wall Street.

The bond market seems to be blind to the economic recovery the equity markets see. Bond yields declined again last week as treasury auctions continue to find plenty of takers. If the economy was indeed recovering as the equity markets believe, bond yields would be substantially higher as worries over growing inflation would dominate bond investor’s minds. The current long-term yields match their lowest levels since mid-May. With our bond model pointing to still lower rates ahead, we could once again be talking about a “3” handle on 30-year bonds, which we last saw during the first quarters equity market collapse. The “debate” in the markets between economic expansion and persistent recession is playing out between equities and bonds. This week could be a turning point in that debate.

By Paul J. Nolte CFA
http://www.hinsdaleassociates.com
mailto:pnolte@hinsdaleassociates.com

Copyright © 2009 Paul J. Nolte - All Rights Reserved.
Paul J Nolte is Director of Investments at Hinsdale Associates of Hinsdale. His qualifications include : Chartered Financial Analyst (CFA) , and a Member Investment Analyst Society of Chicago.

Disclaimer - 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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