THE MARKETS
The bulls remained in control last week as the major averages posted impressive gains for the holiday-shortened week. Although the market appears to be overbought at this juncture, the internals point to higher prices down the road. The Dow Jones Industrial Average ended the week up 249 points (+2.90%) and closed at 8850. The previous high for the year was 8842.62 recorded on January 14th. Fueled by the strength of the tech stocks, the NASDAQ composite has posted gains for seven days in a row. For the week, the index gained 85 points (+5.63%) to finish at 1595, the highest close since June 5, 2002.
Although still bullish, many of our market sentiment indicators are showing mildly deteriorating conditions, suggesting that a lull in action will probably exist over the summer months. There still exists the likelihood of additional upside, however, as speculators betting on the continued downturn scramble to hedge their bets. Likewise, individual investors who are now too highly allocated to bonds and other defensive instruments may also reallocate their portfolios so as not to be left behind. Evidence indicates that this may already be occurring, as the ratio of puts to calls (institutions leveraging highly volatile positions to enhance returns) is now in bullish territory.
The percentage of bullish investment advisors eased back to neutral at 53.6% from a bearish 56.0% the previous week, further evidence of additional upside. For the week ending May 25th, 2003 U.S. equity mutual fund inflows were $2.8 billion compared to inflows of only $500 million the previous week.
THE COMPASS PORTFOLIOS
All indicators continue to prescribe “LONG” positions at the current time, as they have since the late March/early April time period. All of our model portfolios are currently posting impressive gains, including market segments usually considered to be more defensive in nature (i.e. utilities, energy, etc.). No changes are expected in the short term, as the trend and tone of the markets are decidedly bullish. Along the path, some profit-taking should be expected, but as long as the trend continues to be favorable, we shouldn’t need to make any adjustments. We stand ready to begin to prudently book some profits should the need arise.
Frequent readers of this publication know that while we have been eager to participate in any eventual rebound in the markets, we have been cautiously and markedly allocating assets to invested positions when the likelihood of advance has been high. Several times during the bear market (when indicators had pointed to improving conditions) we have chosen to participate, only to have the markets continue their march downward. Re-adjustments were then necessary, to minimize the negative result of a swift change in sentiment. For the past two months, the markets have been more cooperative, and the more bullish prescriptions we acted upon during the prelude to the action in Iraq have resulted in double digit returns across the board, which we are more than happy to accept.
THE ECONOMY
The war of words over the White House’s support for a strong dollar policy continued last week. At the G-8 summit in France, President Bush was quoted as favoring a strong dollar policy, although he left open the possibility of market driven fluctuations. A weak dollar helps companies who export goods (such as automobiles, food, technology, media, etc.) overseas, and hurts foreign companies trying to sell their goods in the U.S. “Old economy” companies would certainly benefit from the weak dollar, although politically a strengthening dollar could result in some leverage abroad.
Last week the government reported that personal income was unchanged during the month of April, as expected per Dow Jones Newswires. Personal spending fell -0.1% versus the +0.1% gain that was expected. However, this was more than offset by the upward revision for March to a gain +0.8% from +0.4%. The personal savings rate rose 3.7%, up from 3.5% from March. Inflation fell 0.2% following March’s 0.4% gain with the core rate, which excludes food and energy prices. These figures represent the Fed-desired price change measure known as the Personal Consumption Expenditures price index or PCE. On a year-over-year basis, the April PCE cooled off to 1.8% from 2.4% for March, with the core moderating to 1.3% from 1.5%.
Bottom line: Despite the importance of this report, the forward-looking May Chicago PMI survey stole the show with a move into expansionary territory (above 50) to 52.2 from 47.6, supported by a surge in production to 60.5 from 51.0 and new orders to 54.6 from 44.6. Regarding income and spending, the Bush tax cut could eventually augment both. Also neither inflation nor deflation pose a threat. Thanks in part to the drop in crude oil, the overall PCE has cooled off. And since the tax-like effect of higher energy costs can actually be considered deflationary on the core rate, price measures that exclude food and energy may eventually rise. While further declines in energy prices would be helpful, price stability looks probable. Under this scenario, the overall PCE could move down into the Fed’s desired range while the core PCE eventually trends higher yet still within the range.
