THE MARKETS
Favorable earnings reports from several Dow components sent the averages higher for the second week in a row. The action was fast and furious as the Dow Jones Industrial Average gained over 1000 points (+14.2%) over a seven trading-day stretch. For the week the Dow gained 472 points (+6.0%) and ended another volatile period at 8322. The NASDAQ also finished in the plus column as it added 77 points (+6.3%) and settled at 1287.
The question at this junction is whether this latest rally is the start of something big or simply another round of short covering. The markets have now tested 7300 on the Dow Jones Industrial Average twice and have held, forming a solid base on which to build. Regardless of whether the final test of that bottom has been made, there is increasing evidence which points to a sustained (but volatile) 2-3 year bull market.
Third-quarter earnings estimates are starting to roll in, and the market has responded positively, in part because the numbers haven’t been as bad as the earnings warning season may have indicated. Companies in industries ranging from autos (General Motors) to healthcare (Abbott Labs) to financial services (Citigroup) and even to technology (Unisys) are making their numbers, albeit while indicating that conditions remain tough.
Previously dire forecasts appear forgotten amid the rally of the past week. However, unless sales growth starts to accelerate, thereby improving the quality of overall corporate profit growth, the recent pattern may be repeated: a sharp sell-off heading into the corporate reporting season, followed by a relief rally as profits are reported. The strength in the economy is not broad enough to sustain the current rally much beyond the 95-1000 level in the S&P 500.
THE COMPASS PORTFOLIOS
A quick reversal in several of the indicators has restored half positions in many portfolios. The trading range on the Dow has been between 7300 and 9000, and the downgrades we acted upon earlier this month came in response to testing the bottom once again. If the trading pattern continues, we believe a retest of the upper part of the range may be in order. Missing that potential move is undesirable, and so we believe cautious buying is certainly warranted. We will be quick to act on a reversal if necessary, but we believe there exists greater upside potential than downside risk between now and the end of the year. Our preference is to eventually remain fully invested, assuming the markets cooperate.
I’ve had some really great conversations with many Appleton Group clients as we continue our quarterly reviews. Opinions about the state of the market have been quite varied, but a tone of resilience and optimism can definitely be heard. While all clients voice strongly the desire to manage investment risk, many have expressed a willingness to retest quality investments in anticipation of a better fourth quarter.
