NOLTE NOTES

Absent big economic news, a few rumors of buyouts affecting select stocks, the markets were focused on energy prices and their new ascent to dizzying heights. Cuts of SUV production by Ford and reports of sales up over 20% of hybrid vehicles (not to mention articles about motorized scooters) indicate consumers are beginning to seriously look at changing their driving habits. While conservation remains a couple of years away, the fact that much of the discussion has finally hit the table is a good start. The financial markets are fretting about the impact upon the consumer, as they are not getting the matching increases in pay to cover their transportation cost increases – meaning their spending pie is getting smaller, impacting an ever growing portion of the economy. Investor sentiment (as measured by Investor’s Intelligence) has steadily increased from just over 30 to over 47, the highest levels since the beginning of the year (when the market was trading at roughly current levels). Next week reports on home sales, sentiment and income/consumption should get plenty of ink and help color the picture of how stressed the consumer is over the rising food/energy prices – the story is not yet complete.
Monday started as a house of fire, as stocks traded well over the 200-day average discussed here last week. However those levels could not be maintained and by the end of the week, it looks as though the failure is triggering a correction of the two-month rally that will initially target the 1350 level on the SP500 – only 2% lower than Friday’s close. Many of our short-term indicators have rolled over and could take a couple of weeks to set themselves up for a summer rally that could begin around July 4th. The key will be watching for deterioration in the longer-term data. While the decline in stocks was large, the market internals matched that of early April. It will be important for stocks to maintain the 1350 level, as a breach of those levels could open the door for another retest of the Jan/March lows of 1270. The Fed has indicated that they are not likely to help out markets with additional rate cuts, so investors will need the assistance of better economic and earnings reports to bolster the next leg higher. If the markets do breakdown, the recent rally may be nothing more than a short-term rally within a long-term downtrend that has yet to be completed. The next few weeks will be key to the direction of stocks.
The bond market has been watching the commodity market closely, looking for signs of some breaks in any of the commodity markets. By the end of the week, commodities were modestly higher, interest rates higher for short-term bonds, a bit lower for long-term bonds. Over the past two months, long-term rates have added nearly half a point to yields, indicating that there is some fear in the bond market about persistently higher commodity prices. Our bond model continues to point to still higher rates over the near term, indicating the commodity rise has not yet finished playing out. Save for the past month, commodity prices have been rising at an annual rate of between 10-30% since 4q02. Now rising at 30%+, we think we are entering a blow-off phase that will eventually bring prices lower.