The market continued on its roller coaster ride as investors again sold the good news and concentrated on the threat of higher interest rates. Friday saw the Dow Jones Industrial Average fall to levels not seen since the end of March as a solid jobs report pointed to higher rates sooner than later. For the week the Dow lost 108 points (-1.06%) and closed at 10117.
The NASDAQ fought to hold onto its 200-day moving average and though down for the week, it surrendered and fell below that average to close out Friday’s session. For the week, the NASDAQ lost 9 points (-.16%) and closed at 1917. For the year, the Dow is down 3.22% while the NASDAQ is down 4.51%.
Concerns over the likelihood of higher interest rates in the coming months continue to dictate the course of the markets. Bulls argue that a Fed Funds rate of 2.25% is already factored into the markets, a full doubling from current levels and that corporate earnings should continue to improve. Bears argue that higher interest rates offer better alternatives to equities at current levels, and that geopolitical concerns, political risks and the effects of high energy prices will continue to cause problems.
THE COMPASS PORTFOLIOS
Minor adjustments to portfolios have been made with several more likely this week. We currently favor defensive positions over offensive positions, with a model allocation standing at approximately 62% cash, 0% fixed income, and 38% equities. We are currently at the bottom of the trading range we’ve discussed over the past month, and a break through the bottom of the range will trigger still more downgrades. Investors familiar with our quantitative approach are aware that upgrades and downgrades have no predictive value, that is to say, are not prescribed as a way to time the markets. However, the prescriptions are made on the assumption that the emerging trend that requires action will continue, which benefits our clients during sustained market moves. Trading ranges are especially difficult to navigate for all investors as going nowhere requires more than a small amount of patience. The significant cash positions we hold at the current time can be put to work in more productive areas down the road, ideally after a period of sustained market weakness. For the time being, raising additional cash may be triggered if the markets are unable to find their footing.
Good news was once again bad news for the markets. The number of Americans seeking unemployment assistance tumbled last week to the lowest level in three-and-a-half years, the government reported, coming in well below economists’ expectations. Initial claims for unemployment insurance dropped by 25,000 to 315,000 in the week ended May 1, the U.S. Labor Department reported. That’s down from the previous week’s revised figure of 340,000, and below estimates for 335,000, according to Briefing.com. The figure is the lowest since October, 28, 2000.
In the broader economy, the effect of higher interest rates on currency prices requires significant attention. The U.S. Treasury’s official position of a strong dollar (roughly equal value between the dollar and the euro, for example) is truly at odds with the market reality. For the better part of the past year-and-a-half the dollar has weakened substantially, its fall unabated by treasury intervention and likely engineered to give an artificial boost to corporate earnings, especially to “old economy” exporters such as Caterpillar, Procter & Gamble, Boeing, and many others. Take away this effect and corporate earnings for exporters are likely to suffer. In a rising interest rate environment, foreign investors need to buy dollars in order to buy higher interest-rate-bearing treasuries, causing the dollar to rise and making foreign earnings worth less.
The high price of oil also continues to be a concern to economists. High energy prices act as a suppressant to the economy, as the price of shipping goods begins to creep into consumer prices, creating additional inflationary pressures. Of additional concern (and getting little press coverage) is the effect of higher prices on the world’s single largest petroleum consumer, the U.S. military. Operating in two remote war theaters creates additional energy demands stemming not only from active military operations but from troop and administrative transportation. Crude Oil has recently been trading near $40 a barrel, with gas prices quickly approaching $2.00 a gallon. Still cheap by world standards, but a shock to U.S. consumers and producers, and an issue which will need to be resolved before the markets can move higher.