THE MARKETS
The market extended its winning streak to four weeks in a row as it closed the month of October with the largest one-month percentage gain (10.6%) since January 1987. After consolidating for most of the week, both the Dow Jones Industrial Average and the NASDAQ put in a strong performance on Friday, resulting in another week of gains. For the week, the Dow gained 74 points (+0.9%) and closed at 8517. The NASDAQ followed suit as it added 29 points (+2.2%) and settled at 1360.
Redemptions of U.S. equity mutual funds have outpaced cash inflows for ten of the last thirteen weeks. For the period ending October 30th, outflows totaled $355 million compared to inflows of $375 million the previous week. This is a scenario we are monitoring very carefully, as it could have a significant impact on the sustainability of the current rally.
It is encouraging that the market is handling poor economic news as investors are now seemingly looking beyond a relatively shallow business dip. Liquidity, meanwhile, is exceptionally high and alternatives to stocks (such as CD rates) remain unappealing. Money market rates, already paltry, would fall further on any additional cut in the fed funds target.
It’s puzzling that many strategists who at the outset of 2002 were looking for mid-single-digit annual rates of gain for several years ahead have not bumped up those forecasts in the light of the 22% drop in the S&P 500 in the past 10 months, especially since trailing four-quarter actual earnings and forward four-quarter estimated earnings have risen, bond yields have fallen and inflation has remained subdued. To be sure, the risk of war with Iraq has increased in the interim. But at the same time, terrorism was a much greater concern early in 2002 (shortly after 9/11), and the risk premium has done its job in bringing down equity valuations.
Standard & Poors notes that there’s still a chance that investors will receive assistance from Washington in 2003, such as elimination of double taxation of dividends and an increase in the maximum annual deduction for net capital losses. The coming year, moreover, will be the third of the four-year presidential term. The S&P 500 has gained an average of 14% in the third year of the election cycle since 1928, vs. 3% in the first year, 5% in the second and 7% in the fourth.
THE COMPASS PORTFOLIOS
We are continuing to fill out portfolio positions, buying carefully and selectively. Portfolios have stabilized from the minimal losses incurred over the last quarter, which is the first order of business. The primary goal is now to capture as much of the market appreciation as possible, while still continuing to manage investment risk. It is encouraging to see the markets returning to a more normalized pattern of moderate volatility with steadily appreciating valuations. With a significant amount of upside potential remaining, we are able to add to client positions without giving up a lot of upside. We will closely monitor market conditions if and when we approach Dow 9000, a significant point of resistance. If the markets are able to break through this ceiling, additional upside is likely. We look forward to embracing those gains if and when they occur, and we believe our clients’ portfolios are well positioned to participate.
Clients will notice that we are using iShares almost exclusively. iShares are mutual funds which trade on an exchange, and which track a specific index such as the S&P 500, NASDAQ 100, Dow Jones Industrial Average, and so on. There are several key advantages to these investments: First, they are very simple to understand in that you always know what you own. If a stock is in a particular index, you own it when you own the iShare. Second, they offer you broad diversification which protects you from the damage one particular stock can inflict. Third, they are inexpensive to own, costing 3¢ per share to buy or sell, and management expenses averaging 0.25%. Lastly, they allow us to elegantly implement the Compass Portfolio Management process our clients have come to expect. iShares are truly a terrific tool which I am proud to use with my clients.
P.S. What a difference a year makes! My son Will turns 1 year old today, and Karen and I couldn’t be happier. He’s a great kid who continues to bring great joy to our lives. He has a vocabulary of five sounds: ma ma, brrrrrrrr, MMMMM, puh puh puh, and kchkchkchk (kind of a grovel). I’m sure he will soon be a regular contributor to this publication!
THE ECONOMY
On Thursday, the Commerce Department said the growth rate of gross domestic product rose to an annualized pace of 3.1 percent in the third quarter, compared with just 1.3 percent in the second quarter. Economists, on average, expected a growth rate of 3.6 percent, according to Briefing.com. GDP is the broadest measure of economic strength.
The Commerce Department said personal income rose 0.4 percent in September while personal spending fell 0.4 percent. Economists, on average, expected income to rise 0.5 percent and spending to fall 0.2 percent. Consumer spending is critical to the total economy’s strength, since it makes up about two-thirds of total GDP.
Separately, the Labor Department said initial jobless claims rose to 410,000 in the week ended Oct. 26 from a revised 394,000 in the prior week, signaling continued weakness in the labor market. Economists had forecast a rise to the key 400,000 level.
The National Association of Purchasing Management-Chicago index fell to 45.9 from 48.1 in September. A reading below 50 indicates a contracting regional manufacturing sector. A reading above 50 signals expansion. The index suffered a surprise drop below 50 last month, showing contraction for the first time in eight months. Economists polled by Briefing.com had forecast the October index at 49.
