It is hard to argue with a bull market – stocks rose on the week breaking through the two-month range that has held the averages captive on better than average volume. The usual giddiness that ensues should carry the Dow through 14,000 (got your 14K hats ready?) before we get a bit of backing and filling “confirming” that the former high end of the trading range is now the market's new floor. Economically speaking, Goldilocks remains in the house (bears aren't home yet!), as the trade deficit widened a bit, but our export business continues to grow (the reason large cap stocks are doing well) and consumer confidence also improved – in the face of higher energy prices.

The meat of the earnings season will cover the next two weeks, with the financial sector highlighted this week. While they are expected to be poor due to the housing and sub-prime mess, the revenues generated from the takeover activity should cushion the blow. The focus this week shifts to Washington, as Bernanke will provide Congress with his assessment of the economy. Wrapped around his testimony will be the inflation reports and housing starts data that may be addressed in the Q&A portion. The Fed's focus is on core inflation data, so the questions may be flying from Congress regarding the food/energy component.

Thursday's breaking of the two month trading range in the averages was impressive, coming on higher volume and the best one day gain in a couple of years. This followed a 150-point decline, spurred by poor reports from housing related companies. Takeover activity and reports that Wal-Mart sales were better than expected was enough to get the market going, and then taken much higher by those betting on the maintenance of the trading range.

The “short covering” rally that tacked on the last 100-150 points will be what gets tested likely this week. Many of our indicators barely budged during the week, with some still declining. Looking at strictly the technical picture, the markets may be able to add another 3-5% onto current levels before taking anything resembling a meaningful break. As usual, there remain concerns in the background as the markets march higher – including higher energy prices, lower dollar and higher interest rates. To be fair, pump prices are within a few cents of year ago levels, however the declining dollar is getting the attention of traders as it represents the loss in confidence in the US economy. While comparisons to '87 are premature, the markets rallied strongly during the year as the dollar declined and rates rapidly rose – today we are missing the rapidly rising rate environment.

Bonds continue to be an enigma to the markets, as they fell a bit last week as commodity prices rose, the dollar fell and stocks rose. While getting a bit closer to a “buy”, the bond model remains in negative territory at “2”, indicating that rates should rise in the weeks ahead. Coming up will be inflation reports that could provide excitement to bond investors. There have been huge differences between the food/energy component of inflation and “core”, which is watched for signs that food/energy are impacting other parts of the supply chain.

The raising or cutting of rates will not impact the food/energy component, however it can have an impact upon the core components – hence the reason core is watched very carefully. Rates may bounce back toward 5.25% in the weeks ahead, especially if the dollar cannot find footing and continues to decline.

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

Copyright © 2007 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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