NOLTE NOTES A Volatile Period As Stock Markets Nosedive in the face of Stagflation

By: Paul_J_Nolte

Ok, so the stock slump we have been looking for was more along the lines of a cliff dive. Worries over the dollar, oil, sub-prime write-offs and the housing markets all conspired last week to push markets down over 4% for the week. Global warming hurt the retail industry, as consumers stayed away from buying their winter garb just yet. We're still confused as to what constitutes “good” weather for shopping. The government's official stats will be released this week and should show retail sales slowed significantly from September's pace.

Also on the docket will be the inflation reports that continue to provide Fed Chairman Bernanke fits. According to his testimony to Congress last week, he is worried about an overall economic slowing, but that the spike in oil prices and a lower dollar could fuel higher inflation rates (which could short circuit the rate cuts). Not to be outdone, Congress managed to pass some “tax reform” that is supposed to cut the bit of the alternative minimum tax, but once the hood gets lifted, many will find that their taxes will be going up – thankfully the weekend came just in time.

While the week was bad, it wasn't as bad as back in July/August on many counts, from number of declining stocks to new lows and even volume. Either the market is setting up for a successful retest of the August lows – or it will be a dismal failure and we begin a journey into a new bear market. At least over the next week or two, we could get a bounce, as the market internals are quickly getting to levels that usually begins a short-term rally. However, unlike past instances of buying the dips, we are getting to the point of selling rallies as many of our longer-term models point to generally lower stock prices ahead.

For example, over the past year, stocks have returned just as much as bonds and the conditions that existed a year ago have not changed – investors generally bullish and valuations high. The volume figures continue to deteriorate, as has the net number of advancing stocks. Historically, September and October have been poor months, with November beginning the best part of the year. When both September and October are positive, the rest of the year has been good. However, as of today, this November ranks among the top three worst since 1950 – with the following year not too promising.

While our bond model remains in positive territory, investors are beginning to bet heavily FOR a continued decline in yields that may actually allow for prices to decline and yields to rise over the next couple of weeks. This may also dovetail well with a temporarily resurgent stock market (as investors switch back to stocks from bonds). This week will have inflation data that as the potential to be worst that expected – forcing yields up. Based upon the comments from Chairman Bernanke, the Fed is stuck between a cooling economy and persistently higher interest rates – a stagflation environment that could be bad for both stock and bond investors. It is too early yet to tell, but this week's data could help.

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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