Financial Markets Full Steam Ahead on Near Zero Interest Rates

By: Paul_J_Nolte

Damn the torpedoes and full speed ahead! At least that seems to be the reaction of the financial markets to not only the good news, but the bad as well. The G20 over the past weekend reiterated the comments from the US Federal Reserve that low (or zero) interest rates will be the order of the day until further notice – meaning it will not pay to keep money in short-term instruments and in order to get any return, investors will need to accept risk.

With the rise of nearly every asset class – from junk bonds to international, from stocks to commodities, it seems as though whenever the party on Wall Street ends, it will end much as it did a year ago – in a river of tears and a cry out for reform. Unfortunately, little has changed over the past year, no reform measures have been passed, FHA is nearly insolvent and the recovery is being pumped by nearly free government money. Yes, at some point it will end, however until it does, let’s keep dancing!

Volume continues to contract as we rapidly approach the holiday seasons. If volume can barely reach 1bil shares, what will it be like over the Christmas week? A couple of volume studies we analyze are on balance volume – or cumulating volume on advancing days and subtracting on declining days and net advancing volume, which looks at the difference between advancing and declining daily volume. Both showed declining trends from early in 2007 and bottomed early in March, each has peaked in early September with a couple of unsuccessful attempts to eclipse those peaks.

If volume continues to expand on declining vs. advancing days over the coming weeks, we will see a more pronounced peak in these metrics, which will point to a more meaningful correction in the equity markets. We are beginning to see more evidence of “non-confirmations” of the rallies in the SP500 and Dow. Smaller stocks peaked with the volume indicators and have formed a “double top” (which looks like an “M”) that effectively puts heavy resistance for small stocks roughly 8% above current readings. There are beginning to be more of these “non-confirmations” that don’t spell immediate market demise, but if they persist, build a strong case for a much larger decline than we have seen since the March bottom.

The bond model has put in the third negative week, again pointing to higher yields in the future – even though the Fed will be keeping rates low for the foreseeable future. The bond model, useful for staying with the trend in bond yields, has done a decent job of being on the correct side of the equity and gold markets.

The theory is that falling bond yields are beneficial for stock prices (forcing investors out of bonds into stocks) and rising rates are good for gold (Fed increases rates to stave off inflationary pressures). For rising rate signals lasting beyond three weeks, gold prices have averaged an 8% gain, while stocks have declined. Unfortunately, the gold/stock model has only worked since ’00, when gold prices stopped declining and have begun their own bull market.

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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