THE MARKETS
Concerns over interest rates continued to keep a lid on blue chips last week while tech stocks sold off. The Dow Jones Industrial Average, which lost 150 points on Tuesday managed to rally for the remainder of the week and finished in the plus column. It was a different story over at the NASDAQ, which was down on all five trading days. The culprit this time around was Cisco Systems (CSCO) who failed to inspire traders with their fiscal fourth quarter results. For the week the Dow posted a slight gain of 38 points (+0.42%) and closed at 9191. The NASDAQ lost 71 points (-4.14%) and settled at 1644. Based on the technical indicators, both the Dow and NASDAQ are considered oversold at this juncture setting up another interesting week.
Market posture and institutional sentiment indicators show improving conditions, suggesting the summer malaise may be coming to an end. For the week ending August 6th, U.S. equity mutual funds had inflows of $359 million compared to outflows of $400 million the previous week.
Looking ahead to long-term market issues, it becomes apparent that the role of any national economy is to meet society’s need. These needs include housing, healthcare, leisure activities, energy, food, transportation, and so on. As the U.S. economy moves toward meeting the needs of all of its citizens, growth becomes more difficult as essential needs become satisfied. Thus, exporting goods and services to other economies unable to meet the needs of its citizens becomes more desirable (and necessary to support our standard of living). However, the U.S. economic model is now largely being replicated around the globe, fostering additional (and sometimes severe) competition for consumer dollars. Over the long run, exporting capitalism and supporting competing economies becomes both a blessing and a curse, and the U.S. economy may continue to face the challenges of a saturated world economy. Chief among these challenges are falling labor prices, as companies export jobs overseas to an increasingly savvy and well-educated work force who are able to work for substantially lower wages. More to follow…
THE COMPASS PORTFOLIOS
Minor adjustments continue as downgrades in utilities and fixed income indicators have triggered additional reductions in these areas. Without a clear trend change in many of the indicators, we have continued to patiently hold positions during the summer months.
The narrow trading range for the key indexes has continued, and a breakout of this range to the downside would lead to additional portfolio adjustments.
THE ECONOMY
The market is currently digesting a major serving of economic data, including reports on second-quarter GDP (up 2.4%) and July employment (payrolls down 44,000). In between, consumer confidence weakened notably. Regarding the GDP report, although the data came in better than most had expected, we don’t think that the economy is off to the races. The 2.4% growth was driven primarily by a 44% spike in government spending, related to the conflict in Iraq. Absent this stimulus, the economy expanded at a weak 0.7% rate. The “quality of growth” analysis raises further questions when integrated with the July jobs report, which continued to show erosion of jobs. Once government stimulus has passed, the economy is back to relying on the consumer to generate growth. That’s not going to happen if companies keep cutting back on employees. The continued trend higher in payroll cuts represents a significant risk to the stock market. If the economy is not generating jobs in the fourth quarter, the gains notched to date in the equity indexes may be surrendered.
It is our belief that the U.S. Federal Reserve Open Market Committee should not continue to cut rates. As the fed funds rate now stands at 1.00% and there aren’t many bullets left in the chamber, recent rate cuts haven’t had a chance to impact the markets, and won’t for another 6-9 months. Also, the stock market has essentially ignored the series of rate cuts so far, and the Fed risks losing further credibility as it “pushes against a string.” Lastly, there’s the danger that the Fed’s low interest rates may build a bubble in housing or some other sector of the economy similar to the bubble built in the stock market in 1999-2000. But from a practical standpoint, the jury is out. And indeed, if the jobs numbers continue to decline, we would look for another 25 basis point cut before the year is out.
U.S. businesses boosted their productivity sharply during the second quarter, squeezing out more output while ratcheting down labor costs, a Labor Department report showed Thursday. U.S. non-farm productivity climbed at a robust 5.7 percent rate, more than twice the revised 2.1 percent pace posted during the first three months of the year. That handily exceeded Wall Street economists’ forecasts for a 4.1 percent increase in second-quarter productivity and implied companies are becoming leaner and more efficient at boosting their output while keeping costs under control. The revised 5.4 percent increase in productivity during 2002 – up from a previously reported 4.8 percent rise – was the strongest for any year since a 6.7 percent jump in 1950 during the Korean War era.
