THE MARKETS
Another roller coaster week saw stocks finish in negative ground for the fifth week in a row. The Dow Jones Industrial Average fell below its July low on Wednesday as it closed at 7683.13. This marked the lowest level for the Dow since October 1st, 1998. The NASDAQ, which closed below its July low last week, bettered that mark again on Wednesday. For the period the Dow lost 285 points (-3.6%) and settled at 7701. The NASDAQ ended the week at 1198 down 23 points (-1.9%).
The Dow Jones Industrial Average hit a four-year low Tuesday, along the way dropping below the July 2002 levels that had previously acted as support. The index, holding about a 100-point loss at 2:00 pm, doubled its downdraft on as expected news that the Federal Reserve had chosen not to alter its interest-rate policy. Interestingly, the normal unanimity from the FOMC was missing, as two dissenting members apparently voted to cut rates further. The senior index did not really need Fed inaction to deepen its gloom. Waves of Blue Chip, old economy companies are now reporting that their earnings expectations are unrealistic in this environment. Notable shortfall candidates Tuesday included Weyerhaeuser and Maytag.
The NASDAQ hit a new six-year low Tuesday; prior to Monday, the NASDAQ had never hit a six-year low in its short history. Cisco’s John Chambers did not rein in profit expectations for the company’s fiscal 2003 first quarter. But he did tell a technology conference in San Francisco that CEOs across the nation had tightened their horizon and could no longer forecast their own end demand with any accuracy.
THE COMPASS PORTFOLIOS
Upgrades triggered by the mid-July through August rally have broken through key support levels, and as a result we have responded proactively by reducing market exposure. We have maintained limited exposure to growth areas, and have taken steps to further protect client assets from further deterioration. If the weakness continues, we expect additional downgrades will be acted upon this week.
Preliminary data indicates that the model portfolios will show single digit losses for the quarter, compared to 15 – 20% losses for the major indexes we track. Market deterioration has occurred in relatively quick fashion, and while our models have responded admirably over the quarter compared to our benchmarks, manageable losses still have occurred. Sentiment has been weak, companies with significant influence in the indexes (such as GE) have suffered greatly, and institutional support has evaporated. We remain watchful for a renewed market strength; however, we are also objectively pragmatic, and will minimize losses to the best of our ability.
Morningstar, an independent provider of financial information, has ranked The Compass Portfolios at or near the top of our peer group on a nationwide basis for the period ending June 30, 2002. New rankings will come out in a few weeks for the most recent quarter, and we anticipate being recognized once again as a top-tier money manager. We’re proud of our accomplishments, but the success of our clients is far and away a more important consideration. We will continue to balance risk with the potential for reward, and we look forward to a friendlier investment climate in the future.
THE ECONOMY
The economy provided little in the way of help. Consumer confidence was slightly above consensus, but that consensus was bearish indeed; and the reading, at 93.5, was the lowest since November 2001. Investors dread losing the consumer, the economy’s chief prop, now that the recovery in corporate capital spending is fizzling.
United Kingdom Prime Minister Tony Blair listed Saddam Hussein’s weapons stockpile and violations, a move that greatly cheered Administration officials — who badly need an ally — and may provide enough momentum to win the struggle for Congressional war authorization. Pundits have been assaying the economic implications of various U.S. strategies on Iraq, from a quick victory to a protracted struggle to further importation of terrorism at home. The scenario least discussed, deadlock — whereby the Congress, the U.N., the President, and world opinion engage in a slow dance that leaves us right where we are a year from now — could be the one that most threatens the recovery.
Right now, war tensions have frozen capital-spending decisions. If they remain in a deep freeze for a year, the consumer will have long since left the building. Lost in all this gloom is the fact that the market is displaying signs of an oversold condition, certainly a short-term oversold. No one is willing to venture that the double bottom we are now experiencing is indicative of the real trough. Investors may be able to get some short-term gains here if they are willing to stop losses in any further swoon.
Market bears like to compare the U.S. economy and financial markets to those of Japan at its peak in the 1980s. The implications, as Japan’s stock market indexes continue to bounce around at 19-year lows are clear: there’s a lot more pain ahead for domestic investors, if the U.S. follows the Japan model. In our view, though, there are clear, important differences between the economies and the government policies of the two nations at his time. Overall GDP, retail sales and wages are all on the upswing, compared to outright declines in Japan. Deflation? A problem in Japan, but prices in the States are rising at 1.5% — and are expected to climb further. As for government policies, Japan’s monetarists are stuck in neutral with long-term interest rates at about 1%, while the U.S. Fed still has some room to maneuver. On the fiscal side, the U.S. balance sheet is in far better shape.
