THE MARKETS
Concerns about corporate profits and global tensions kept a lid on the market last week as the Dow Jones Industrial Average traded in a narrow range around the 8500 area. Markets don’t trade in a tight range for long and we’d expect to see this pattern resolve itself within the next week or so. For the week, the Dow lost 212 points and closed at 8433 (-2.45%). On a percentage basis the NASDAQ fared much worse as it lost 60 points (-4.22%) and settled at 1362.
For the period ending December 11th, U.S. equity mutual funds had inflows totaling $1.8 billion compared to outflows of $2.1 billion the previous week. The percentage of bullish investment advisors was steady at 50.5% from 51.1%. Readings over 54% are regarded as bearish.
I’d like to share with you a few thoughts on the current state of the market. One of the legacies of the worst bear market of the postwar period is an investor with low tolerance for disappointments and a heightened awareness of risk. Thus, the recovery is bound to be erratic and may often seem in peril.
Potential returns from alternatives to equities, meanwhile, are uninspiring. Treasuries, though a hedge against stock weakness, provide low yields and would be expected to ease in price as credit demand picks up in a strengthening economy. Returns from cash equivalents are paltry, and real estate now looks expensive.
Lastly, stock valuations seem high for the beginning of a bull market. But they should be viewed in the context of a different, if not new, economy and the possibility that a multi-year earnings expansion lies ahead. Thanks to new technologies, labor productivity uncharacteristically rose through the recent recession and remains in a strong upward trend. Although job losses occur as productivity increases, unemployment is modest for this stage of the economic cycle and should turn down around mid-year.
THE COMPASS PORTFOLIOS
No changes to our models this week, despite the profit taking in the equities markets. We continue to favor equities over other assets, a position which reflects enhanced support of the markets by the large institutions (such as mutual funds, institutional pension plan managers, and hedge funds). As the year comes to a close, most indicators are currently positive, and point to a healthier market at this time. While risks to portfolios still loom large (especially in the area of fixed income securities), a more normalized investment climate seems to be emerging, with a focus on real earnings, productivity gains, and improved capital spending in the year ahead.
THE ECONOMY
The producer price index, which measures prices paid to U.S. factories, farmers, and other producers, unexpectedly plunged 0.4% in November — the largest decline in six months — as costs declined for gasoline, computers and cars, a government report showed. The weak PPI was released just days after unemployment figures suggested that the job market is still shedding a high number of jobs. Weekly jobless claims spiked in the most recent data, and the national unemployment rate is now 6%.
The bigger lingering question in the market remains whether U.S. companies will soon begin spending again on capital investment. Says The Bank Credit Analyst, in its morning economic report: “With cash flows improving, balance sheets being repaired and the return on investment still attractive, the odds are good that capital spending will surprise on the upside in the coming year.”
Still, there clearly are risks to the recovery. The dollar in currency trading earlier Friday plunged to its weakest level in almost three years against the euro and fell against the yen after the release of the drop in producer prices. The decline raised concerns that profit growth at U.S. companies will slow.
