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Nolte Note for the Week of November 23, 2009

|Includes: DryShips Inc. (DRYS)

Finance banter is pleased to announce Paul Nolte as a contributor. Paul Nolte, Managing Director at Dearborn Partners, provides portfolio management services to individual and institutional clients and is a member of the firm’s Investment Committee.

If this is the recovery, I would hate to see what a recession looks like!! Housing data released in the last week showed a still lousy housing market – from home builder confidence index that declined by a point to remain well under 20 (50 is “balanced”). Even traffic for new homes was near record lows. Housing starts and permits (a leading indicator of future starts) both fell again. The Mortgage Bankers report of home purchases fell to a new low and are still down 15% vs. year ago levels. Manufacturing, a mini-bastion of relative health, saw a modest rise in capacity usage, although output was stable and inventories fell. The much hoped for inventory-rebuilding process remains elusively somewhere in the future. On top of all that, Treasury Secretary Geithner defended the administrations actions while Fed Chief Bernanke made a rare comment on the declining dollar. A short week with a short list of things to be economically thankful for, so take comfort with family and friends and enjoy the time together.

Wall Street seems to have taken off early for the Thanksgiving week, as volume once again contracted and has been 5-25% below the past four week average since the opening days of the month. The shortened week will contract many of the economic releases into the first three trading days, but the focus of the markets seem to be strictly on the dollar. Moving nearly exactly opposite of the dollar on a daily basis, any significant (and surprising) rally in the dollar could bring about a quick decline in stocks. Our longer-term indicators have already rolled over and have been declining for a few weeks, while many of the daily readings are attempting to surpass their highs made in late September. It is these divergences, while they can last for quite some time, are early warning signs not everyone in the markets are dancing to the same tune. Small cap stocks have been under performing the SP500 since mid-September and have turned lower from their second attempt at new recovery highs. The international markets, due to some modest strengthening of the dollar, is also beginning to under perform the SP500. Given that the correlations between each of the markets have been high since the bottom in March, we could see a global correction in the equity and corporate bond market sometime in the next 6 months.

For the first time in four weeks, the bond model has flipped over to a positive reading, with a decline in the yield on 30-year bonds getting just under 4.3%. The big news in bonds was the negative yield on short-term treasuries – meaning you automatically lost money making the investment. This was last seen in this market during the financial collapse last year, however this year money managers are looking for the most liquid place to stash cash until yearend. The difference between the short and long-term bonds remains well above 4% and based upon historical duration of 4% spreads, we could see the spread stay in this range until near mid-year 2010. Commodity prices and gold continued their rise as the dollar declined. Keep an eye on long-bonds, as a further decline likely will spell additional deflationary pressure.

The doubling of the Baltic Dry Index since the end of September should have been a boon to marine transport companies, however it has only just been this week that we have seen the group move – largely due to a jump in Nordic Atlantic Transport (NYSE:NAT). The group has followed the market down from last year’s peak, however have yet to truly recover and many stocks remain mired near multi-year lows. The same can be said for the delivery group – save for Federal Express (NYSE:FDX), which has done a better job of following the markets higher, doubling from the March lows. We have posed the question in the past, if the economy is so good, why are these stocks doing so poorly? Even the rails, especially prior to the buyout of Burlington by Warren Buffett, struggled to find higher ground. Truckers generally peaked with the broad market in September and have fallen since then, another indication of the underlying groups not doing as well as the headline economic figures would have us all believe. The trade continues to be heavily tilted toward the basic materials, with gold and mining companies leading the way. Joined recently by coal stocks, these groups will struggle to continue their out performance if the underlying economic growth does not materialize. While China may be the rage, it will be hard – even for a country of their size and ability to use goods, to hold these markets up all by themselves.

While the Dow managed a gain, many other indices were down on the week. The coming week could be modestly higher as historically the week of Thanksgiving has been higher, however we expect the markets could be soft early in December. We are likely to make a shift in our models toward SP500 names, away from small cap issues. Bond investors should stay relatively short, although yields remain extremely low (less than 0.7% for 2-year treasury bonds).

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.

Disclosure: None