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Nolte Notes for the week of March 1st

If last week was any indication, March will indeed come in like a lion. It looked pretty quiet judging by the week to week close, however the daily 100 point swings pointed to more concerns from investors aboutnot only the health of the US economy, but that of countries around the world. The data here in the US remains split, with manufacturing showing decent strength, although backing out airplane orders, durablegood orders were down slightly. Real estate continues to struggle to find firm footing, as new constructionhit a new low for this cycle and existing home sales were less than stellar. A backup in unemployment claims bodes ill for the unemployment report due this Friday, although weather may take the blame for any poor number. Around the world, the European countries look weak as concerns over sovereign debtclouds sustained economic development while in the Far East, China continues to try to rein in some ofthe more speculative parts of their economy. Finally, as we turn the page on the month, the Oracle (east) of Omaha has declared a bottom in housing may be a mere year away. Playing the star again, Warren Buffett shot a few arrows at bankers (although he has large investments here) and in a nod to his newestinvestment, encouraged those to (ride 16 hours and) take the rails to the next meeting.

While the markets were close to unchanged for the week, they did put in a decent February, reversingsome of January’s decline. With earnings season finished, investors will be getting hit with moreeconomic data over the next two weeks that should help figure out whither the markets go. While volumeremains an issue, it continues to expand on market down days and contract when the markets rise, a poor sign for the health of the market. The major averages have stayed within a roughly 5% range fromtheir Friday’s close since mid-October, providing traders plenty of opportunities but frustrating investors.While many of the market internals are pointing to future weakness in the averages, it has been hard for the markets to stay down too long. One bright spot has been the heavy selling volume compared tobuying volume over the past month. Typically when either up or down volume is excessive in either direction, it sets up for a move in the opposite direction. Advancing volume normally is between 40 and55% of total volume over a five-week period. Since the end of September, when the markets began their “stall” phase, the volume has moved from roughly 55% to 41% at the last reading and is now at the lowestpoint since the market bottom of ’09. It is bullish sign among the sea of bearish signals.

While bonds rallied on the week as the economic data in the US looked weak and favorable comments from Fed chief Ben Bernanke that rates would remain very low for the foreseeable future, the bond modelhas not moved to a “buy”, as commodity and utility prices have not yet moved enough to generate asignal. The debate on rates centers on the impact of monetary policy, whether the very easy money will create inflation or have no impact. It will depend upon how the money is used, spent in the economy orput under a mattress. For now, money is spent very carefully and slowly, so no inflationary pressures.However, if the economy ever gets ramped up, then we could easily see a more vigorous inflation rate that would warrant a complete change in investing tactics.

All of the major asset classes, from international to REITs are above their long-term averages and warrantholding. However, with the strength of the dollar, international investing has become a bit morepedestrian. As a result, we have cut our international exposure in favor of small cap stocks, which have done very well so far this year. Bonds as an asset class have bounced around from “buys” to “sells” frequently over the past few months, so trying to time the changes has proven fruitless. We have overweighted bonds in portfolios and so far they have had a positive showing this year. The commodity corner has been truly a mixed bag, with oil prices relatively unchanged after dropping 10% early in the year only to bounce back. Gold prices are higher, although they have been in a much narrower range. Thecommodity indices are generally a bit lower for the year. REITs have been similar to oil prices, down a bunch early and up a bunch during February. As a result, we are likely to stay somewhat defensive withan overweight in bonds, underweight in foreign holdings and minor holdings in both commodity and realestate. Given the long and generally sideways actions of the markets over the past four months, a bitmove in either direction would force us to make changes, but for now – we are standing pat.

While the day-to-day gyrations of the markets are unnerving, they have been well behaved and sidewayswithin a fairly well defined range since mid-October. As a result, we do not yet feel compelled to changeour cautious stance toward the equity markets. While bonds rallied last week, they too have been somewhat range bound and have provided a solid gain so far this year, hence the reason we are staying with an overweight in bonds.



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