THE MARKETS
Sparked by an increased revenue forecast by Intel for the current quarter, both the Dow Jones Industrial Average and the NASDAQ broke out to the upside of their recent trading ranges. Strong economic data, such as the jobless claims falling to their lowest level in six months, also contributed to pushing the averages higher. For the week the Dow gained 27 points (+0.29%) and closed at 9348. Earlier in the week the Dow closed at 9428.90 which was the highest close since June 20. The NASDAQ, led by Cisco Systems, Microsoft and Intel, recorded a 16-month high as it gained 63 points (+3.70%) for the week and closed at 1765.
Fireworks early Friday morning sputtered as Intel’s increased revenue guidance wasn’t enough to support the rest of the markets. Bank stocks (such as Citigroup and J.P. Morgan) faltered, and led to a disappointing but still positive overall result for the week.
Institutional sentiment is now indicating a more neutral stance due to an increase in the percentage of bullish investment advisors to a bearish 55.1%. Protective option activity (the ratio measuring institutional activity designed to protect recent gains) increased sharply to 1.57 up from last week’s 1.24. For the week ending August 13th, 2003 U.S. equity mutual funds had solid inflows of $2.6 billion compared to inflows of $3.5 billion the previous week.
THE COMPASS PORTFOLIOS
No changes to our models once again. Slow and steady progress amid low volume has left our models in good shape despite Friday’s volatile session. Only one week left in the Summer session, as institutional desks will once again be fully staffed. Look for increased volume (and volatility) as the watershed season begins next week. All models are still positive, and will likely remain so for the balance of the week.
THE ECONOMY
The red ink from the U.S. Treasury has turned into a torrent, with the annual budget deficit deepening in July to a record $324 billion. The growing shortfall further highlights the deterioration in the government’s finances this year. Not surprisingly, the expanding deficit for fiscal 2003, which ends September 30, has generated a considerable amount of hand wringing among Democrats and Republicans alike.
Their concerns are certainly not out of place, given that the U.S. government’s books were in surplus only two years ago. The speed with which the Bush Administration and Congress have plunged into deficit spending again is worrisome. But let’s take a step back: when the deficit is put in the context of previous periods of rising government debt, the impending shortfall doesn’t appear to be as alarming.
As a percentage of GDP, this deficit should be well short of the record 5.7% in 1983. And looking ahead, a stronger economy, along with a reduced deficit, should sharply reduce the deficit’s share of future GDP. A deficit in line with the Office on Management and Budget (OMB)’s forecast for 2004 would pull the ratio to 3.5% of anticipated GDP. Even the OMB’s increasingly unrealistic deficit estimate for 2004, when compared to our growth estimate, translates to 4.2% of GDP.
The upshot for the markets: Given the elevated deficit fears just a few months ago, a fiscal 2003 figure that fell short of the OMB’s worst-case scenario would likely be viewed favorably by Treasury market players. Moreover, since an even larger deficit next year is looking increasingly unlikely, the budget figures may help support bond prices — and keep a lid on interest rates — through 2004.
