With the memory of 9/11 in the background, traders shifted their attention last week to the possibility of a war with Iraq. On Wednesday the Dow Jones Industrial Average soared above its 50-day moving average, 8613, as the high for the day touched 8726. Closing above this average would have been a positive for the market going forward. However for the second time in the last three weeks it could not hold above this important resistance level. For the week the Dow lost 115 points (-1.4%) and closed at 8311. The NASDAQ was also soft losing 4 points (-0.3%) and ended the week at 1291.
Tough talk from the President and gloomy talk from the banking chief combined to send stocks spiraling lower Thursday. President Bush, speaking before the United Nations, listed past transgressions and deceptions by Saddam Hussein, suggesting that the U.S. will put no stock in future promises by the Iraqi leader. The President laid out severe terms for dismantling Iraqi military programs, terms that are unlikely to be met. Investors concluded that the United States is on course for war, and the markets responded unhappily.
Even without these sobering words from two of the nation’s leaders, stocks would have been under pressure. McDonald’s announced a surprise conference call for next week, in which analysts expect the company to scale back its earnings outlook. Any day on which defense stocks are the sole group to rally is likely to be a tough day for the overall market. Right now, the consumer is the only thing keeping the economy from slipping into recession. Signs that a war with Iraq is inevitable could potentially cause new caution among consumers, leaving economic prospects even more unsettled. On Friday, Honeywell, a Dow component and market bellwether announced significant reductions in quarterly and full-year estimates, resulting in a 15% drop by mid-day.
On a side note, Lucent Technologies (the telecom equipment and fiber optic cable manufacturer) announced a further 20% anticipated drop in revenues during the current quarter. This is surprising after I just received a children’s catalogue sporting a fiber optic enhanced Harry Potter costume which my son Will would love to wear for Halloween. Apparently the fiber optic industry isn’t recovering so quickly after all!
THE COMPASS PORTFOLIOS
The upgrades we acted upon over the past three weeks have yet to move into positive territory, a condition required before additional capital would be invested. Upgrades (or downgrades) are prescribed when sufficient evidence has been gathered to support the premise that the market has not only turned, but that a continuation of the new trend is likely. As of the last volley of upgrades, and markets have not demonstrated the ability to gain momentum, and have also not yet demonstrated that the trend upward is sustainable. However, we have not downgraded our market prescriptions as of last Friday, and we continue to show a model posture of 40% equities, 20% bonds, and 40% money market. Our goal is to follow our model portfolio discipline rigidly, yet allowing each client to customize his/her portfolio.
The majority of the week’s economic news came on Thursday as Fed Chairman Greenspan, detailed on a region by region basis how the nascent expansion was withering on the vine. In a somewhat surprising development, the Fed Chair pointed to federal deficit spending – not the capital spending drought, or the stock market, or the corporate scandals, or the over-extended consumer – as having the potential to derail the recovery. The unstated message from the Fed was that a full war footing would mean even deeper deficits, and even more trouble for the recovery. While not an Administration official, Mr. Greenspan’s implicit message appeared to be a condemnation of the coming showdown with Iraq. The Fed Chair thus becomes yet another voice of caution with a solidly conservative track record.
Mr. Greenspan may be caught between the proverbial rock and a hard place when it comes to the future direction of interest rates. A weakening recovery tends to support the position of lowered short-term interest rates over the next six to nine months; however, his comments on Thursday seemed to be testing the market’s reaction to higher interest rates, a typical side-effect of government deficit spending. Early estimates call for a $200 billion budget shortfall this year, and raising that kind of capital in a weakened economy may prove economically dangerous. Foreign governments (including our enemies) know this, and may ultimately drive our decision to act (or not to act) on Iraq.
In a spot of bright news, the consumer continued to bolster the economy in August. Retail sales for the month showed an increase of 0.8%, much better than the 0.4% rise forecasted by economists, and up from the 0.8% dip in July. Excluding auto sales, the increase on the month was 0.4%. The data on autos surprised even some of the most optimistic forecasts, climbing 1.9%, while furniture gained 1.7% and sporting goods jumped 2.9%. Gains suggested “nesting,” (buying household items) continues to dominate purchases. But another report painted a different picture of consumers’ mood. A preliminary September reading for the University of Michigan’s consumer sentiment came in at 86.2, down from August’s final reading of 87.6 and lower than the 88.0 projected by economists.