Just in time for the weakest part of the calendar for equities and talk of Hindenburg Omens, double dip recessions and bond bubbles have gotten louder, putting the investment community on the alert. Weak housing data and a revision downward for second quarter GDP (that is sooo early year!) coupled with a still poor labor market have investors pouring money into bonds and bond funds at a rate that is making many concerned about a bubble. To be sure, there is plenty of debt to buy, but yields on the 10-year Treasury touched 2.50% before a nasty Friday pushed them back over 2.6%. What if everyone is already fearful? Judging by Investment Advisor sentiment as well as Individual Investor readings among the lowest in 12 months, maybe everyone has already battened down the hatches and unlike the stifling heat of summer, the fall is a glorious celebration of the changing seasons. Historically, both the Presidential cycle and decennial cycle point to weak September through October markets, but ’80 and ’96 proved an exception to the rule. With everyone standing on the port side, it maybe time to begin leaning starboard.

As mentioned above, the markets are heading into the worst part of the year, August/September, which is usually worse during a mid-term election. For all the bad press about October, during a mid-term election returns have historically been positive (3 of 14 since ’52) with only 1976 –8.7% return the only large decline in the bunch. September and June have been generally poor during mid-term elections (this year, June was down over 5%). So far this year, the markets have followed the cycle, with only April’s positive return trumping the expectation for a modest decline. However, sentiment is rather poor right now as investors are getting used to the thought of selling stocks due to a poor economy and buying bonds. As Friday’s jump in stocks and decline in bonds demonstrated - don’t get too comfortable in a “sure thing” investment. Given the bearish sentiment, it is possible Sept. and Oct could flip-flop, with a positive September and a negative October heading into the election.

Friday’s big reversal in bonds (prices fell, yields rose) as comments from the economic confab in Jackson Hole by Fed Chief Bernanke make their way to the corridors of Wall Street. Bernanke indicated that while many have declared the Fed impotent to fight the current economic malaise, he still had plenty of firepower to use and would IF the economy were to weaken further. Bond investors took that to mean more buying of Treasury securities and additional flooding of the economy with cheap/easy money that would further erode the value of the dollar and consumer’s purchasing power. Bonds may indeed be at a tipping point, having fallen from 4 to 2.5% on the 10-year Treasury in a mere 4 months. How much will yields rise before their next surge lower? Given the bond model remains bullish, best guess would be to see yields rise above 3% over the next couple of months.

As the markets declined in August, we are seeing a return toward the more defensive names, even though on a day-to-day basis there have been large price swings from the technology, industrial and basic material sectors. For example, falling out of the top rankings are the airlines, autos and aerospace/defense, while moving higher are vintners, soft drinks and tobacco. It can be argued that the business models for at least airlines and autos are not the most conservative and are generally very volatile depending upon consumer spending and energy prices. One interesting group that has been in the doghouse for quite some time is the building retailers. Really only consisting of Home Depot (HD) and Lowes (LOW), they both rose over the past two weeks while the broad markets declined – and too in the face of rough housing data for both existing and new homes. HD has been in a long-term decline from 2000, with a bottom around 22 that has been hit twice since ’00. If recent strength can hold, the stock can build toward the recent highs of 36-37. If those are broken, the mid-40s would be next, however unless earnings can improve dramatically over the next year, valuations only support a move toward the mid 30s.

More concerning over the short-term is the reversal Friday in bonds, from a generally declining yield environment to rising. The coming week should answer whether Friday’s trading was a one-day wonder or a new trend. If bonds have reversed course, we will begin to shorten up maturities to 5 years and get a bit more aggressive in the equity market. A loaded economic calendar and the financial markets’ reaction to the news will likely determine the trend for the new month.

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.