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Nolte Notes for August 16th 2010

There’s something happening here, what it is ain’t exactly clear, but Ben Bernanke is going to be aware. At least that seemed to be the sentiment coming from the Fed meeting on Wednesday. However, the financial markets were having none of it, thinking the Fed no longer has the ability to stave off what many believe to be an economy on the cusp of a renewed recession. Jobless claims remain near January levels and have yet to break below 400,000 on a weekly basis, lower mortgage rates have yet to spur housing activity. Even refinancing, at double last years pace is well behind historic levels given the decline in rates. Retail sales, excluding cars and spending at the pump was down as well as poor guidance from JCPenny and Nordstrom’s adding to investor’s worry about even a modest recovery. At the mid-way point of the third quarter, it feels as though the light at the end of the tunnel we saw at the start of the year is just another express train! In will be a light week for “heavy” economic data, investors will likely take their cues from data abroad and maybe the Tuesday confab regarding what to do with Fannie and Freddie – everybody look what’s going down.

Save for the six-week foray in late March through April to the yearly highs, the SP500 has been stuck between roughly 1150 on the high side and 1025 on the low side for 11 months. This has coincided with the lack of solid economic data, although corporate earnings have recovered nicely during the period. The beginning of the period also marks the shift from a rising market on rising volume to a rising market on declining volume (and falling on higher volume). It is as though investors have a hair trigger on selling vs. a slow draw on buying, even though 56% of the trading days over the past 11 months were positive. Another fun fact and maybe why investors are a bit fed up with the markets: one third of the trading days have seen 100+ point swings in the Dow over that 11 month period. Unless we see very strong economic data over the next couple of weeks, the stock markets could drift lower toward the bottom of the trading range.

The talk of a double dip recession (or just the continuation of the last one!) has drawn investors into the bond market in droves, pushing the 10-year government bond yield down below 2.75%. Investors, with yields at these levels do not believe inflation is going to be an issue anytime soon, confirmed last week with the low consumer price report (producer prices due this week). Mortgage rates are now at all-time lows and so far have failed at significantly boosting housing activity. Meanwhile excess cash sits idle within the banking system and on corporate balance sheets awaiting a profitable use other than collecting risk-free 2% returns. The bond model remains buried in positive territory, indicating the path of least resistance for bond yields is lower still.

A quick check of the various major asset classes will demonstrate the frustration from a generally sideways market we have been experiencing. Just last week, all seven of the major asset classes we follow were above their long-term averages, this week, just three. The numbers have bounced around from seven to two and back to seven and again to two since April. This is very different from the ’09 experience, when bonds were the only asset class doing well until May, when small and emerging market stocks began their run. By the end of July bonds were the only one out of the spotlight as has been the case through April. From April on the only asset classes to stay above their long-term averages were bonds and REITs. The shift away from the riskier assets to more income-oriented assets is also true when looking at domestic asset classes, where telecom and utilities have taken the top performance spots over the past two months. The big question is now how long this domination is likely to last. Best guess is that it can easily last into the early part of ’11 as investors continue to reduce their overall portfolio risk and focus more on “sure things” such as solid cash flow, dividends and steady sales/earnings growth.

The Fed comments gave investors little to cheer as the markets remain range bound in a 12% range. Opportunities still exist in emerging markets and domestically in the “blue chip” large companies, especially those paying an ever-increasing dividend each year. Little change for bond investors’ as the 7-10 year range seems to be the sweet spot: some income and some appreciation potential.

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