The markets entered the month of September with a bang as both the Dow Jones Industrial Average and the NASDAQ took it on the chin. Tuesday’s sell off left the Dow down 355.45 points (-4.1%) while the NASDAQ dropped 51.01 points (-3.8%). Tuesday’s drubbing set the stage for a seesaw week. On Wednesday the Dow snapped back gaining 117 points only to get slammed again on Thursday losing 141 points. Friday saw the averages back in the plus column as the Dow gained 143 points (+1.7%) while the NASDAQ surged over 3.5%. For the holiday shortened period, the Dow lost 237 points (-2.7%) and closed at 8437. The NASDAQ fared a little better as it only lost 19 points (-1.5%) and ended the week at 1295.
The irony in the trading year to date is that the market was only able to gain any real traction in the past five weeks — a period in which many recovery boosters have begun to wonder aloud if the economy is on the verge of stumbling. Such a trading pattern could be suggesting that, beyond any considerations regarding the timing and vigor of recovery, the majority of investors simply regard stocks as oversold. To keep this market rally going, investors need to believe there is more value to uncover; and for that to happen, the feeble earnings recovery of the second quarter must get more muscular in the second half of the year.
Institutional demand for stocks, strong in late July and a good part of August has turned spotty. Apparently, the feeling is that stocks bounced too far, especially in light of the Iraq invasion talk and terrorism threat.
But we don’t see the shift away from stocks continuing for very long. Prices of bonds, the main alternative investment, have risen to the point where relative value considerations dictate increased emphasis on equities in institutional portfolios. The benchmark 10-year T-note yield, which moves inversely to the price, hit a 19-year low of 3.9% last week.
THE COMPASS PORTFOLIOS
Our models turned slightly more positive several weeks ago, and we have followed the disciplined approach we believe is so important. Our models currently prescribe a guarded stance, and so we continue to overweight on bonds and money market, with only a 40% model allocation to the equity markets. The momentum which the markets demonstrated heading into mid August has fizzled, and further adjustments may need to be made. We are comfortable with our current allocations, and we believe that limited exposure to the stock markets is a prudent posture. Many institutional money managers have begun to reduce their own cash positions in anticipation of a market rebound in the third and fourth quarters, and if the bear market in corporate earnings is indeed over as many economists suggest, our current posture will be very beneficial. But we are ever skeptical, as every money manager should always be, and if further adjustments need to be made we stand ready to take action.
While the welcomed upbeat employment news from the August labor report is just what this market needed, the trend might not continue into October. Despite its importance, the labor report is a lagging indicator. With help-wanted ads and jobless claims soft along with lackluster job growth indicated by the Consumer Confidence report and each of the forward-looking ISM surveys, don’t be surprised if we lose some of this improvement in the next labor report. Fortunately, the lagged effect of noticeable money supply growth since April could reinvigorate labor conditions by the end of the year and into 2003.
While virtually every key component of the August jobs report was appealing, much more improvement is necessary. Non-farm payrolls gained slight traction, gaining 39,000 jobs in August according to the “Establishment” side of this overall labor report survey. A rise of 40,000 was forecast per Dow Jones Newswires. July was revised up to +67,000 from +6,000. The issue going forward, though, is that payroll growth needs to average better than +130,000 per month in order to absorb new job entrants and be able to reduce the unemployment rate.
It should be noted that unemployment experiences a healthy drop. The 5.7 percent result matched the lowest rate since March 2002 and is below 2002’s high of 6.0 percent set in April. What makes this believable is the similar trend seen in the Fed’s more comprehensive “augmented” unemployment rate, which includes disgruntled job seekers. The trend lower is more important than the level.