THE MARKETS
An explosive rally on Friday was enough to pull the major averages out of their slump as the Dow Jones Industrial Average ended the week in positive territory for the first time in seven weeks. On the negative side three indexes, the NASDAQ, S&P 500 and the Dow Jones Utilities took out their September lows on Tuesday (07/03/02) as the selling pressure intensified. For the holiday-shortened period, the Dow gained 136 points (+1.5%) and closed at 9379. The NASDAQ failed to follow suit however as it lost 15 points (-1.1%) and settled at 1448.
New revelations of loan defaults and possible fraudulent accounting from WorldCom set a negative tone for the market early in the week, leading to another huge correction on heavy volume. About 1.5 billion WorldCom shares traded hands during the regular session, as the stock dropped from $0.83 at the open to $0.06 at the close. That led to more than 3 billion shares trading on the NASDAQ, in what was supposed to be light trading in the holiday-shortened week. Trading on the NYSE was more along that pattern, with volume for much of the day about 20% below typical daily levels. The volume of trading did pick up in the session’s final hour, however, and the bias was decidedly negative. Companies that provide payroll and other services to WorldCom, such as EDS, were decidedly weak.
The specter of terrorist attacks on July 4 continued to hang over the market, and investors could find no formula for pricing in such an event, other than heavy selling. Friday’s relief rally was a “no news is good news” event, as the quiet holiday eased fears that had suppressed equity prices ahead of July 4th.
The heavy volume and panic selling are typical precedents for a market bottom, but in the age of terrorism and aggressive accounting, precedents count for little. The market’s ability to evaluate company specific data reached new heights Monday, as investors rewarded the shares of 3M even as they were pulverizing virtually every other stock. 3M’s businesses stretch across virtually every sector of the economy, and it can’t be doing so much better than expectations if its trading partners are not doing well too.
THE COMPASS PORTFOLIOS
No changes to our portfolios last week, although an early upgrade to the Dow is likely, given that we have broken a seven-week trend of losses. We continue to be defensive, and invested positions focus on large-cap value (i.e. manufacturing, banking, pharmaceuticals, defense, etc.). The significant cash reserves that our clients are carrying have helped to soften losses during the recently ended quarter, in many cases holding losses in the 3-4% range (vs. the 10-25% range for unmanaged portfolios). The true value will be realized when the cash reserves are put to work as the market returns to health. That day is not today, although we remain watchful and hopeful that the economic rebound will translate into higher equity prices in the near future.
THE ECONOMY
The U.S. added a less-than-expected 36,000 new jobs during June, confirmation that the economy is indeed on a slower track of recovery. Meanwhile, the initial report of 41,000 new jobs in May was shaved to a mere 24,000-job gain. This gradual recovery doesn’t bode well for a vibrant economic performance. The single most important economic indicator regarding future economic activity is the level of employment. Remember, people will consume despite dwindling portfolios and even when faced with higher prices, but nobody spends without a job. And perhaps more than anytime during the past year and a half, the economy needs greater income growth.
Once again, manufacturing was the primary source of weakness, shedding some 23,000 jobs. New orders placed with the nation’s plants and factories rose 0.7% in May, following a similar 0.7% increase in April. Excluding the volatile transportation component, new orders rose 0.7%, the third consecutive monthly increase. Perhaps the most comforting news came with a 4.3% increase in new orders for non-defense capital goods. This excellent proxy for total business investment suggests that second-quarter investment spending may turn positive – a condition that hasn’t occurred in five quarters.
Encouragingly, the number of total private hours worked edged up to 34.3 in June from 34.2 in May and the number of manufacturing hours worked totaled 41.1 in June, up from 40.9 in May. Overtime hours advanced in June to 4.3 hours. It is clear that manufacturing activity has definitively turned the corner and better times are in store. June employment growth was largely the result of greater government (+23,000) and construction (+14,000) job additions. The U.S. government is currently on a spending spree, in particular on security and defense-related goods.
In addition, the mid-term election is prompting many candidates to solicit votes through new hires. We don’t see a slowdown in government job growth until the new year. Torrid housing activity is clearly driving the increase in construction payrolls. New housing starts surged 11.6% in May to a seasonally adjusted annual rate of 1.73 million units –- the largest monthly gain in about seven years, and the fifth highest reading in the past 15 years. The increase in the unemployment rate to 5.9% is a bit worrisome as it brings into question the peak of 6.0% in April. With uncertainty plaguing the financial markets and the sluggish labor market recovery, it is difficult to see how the economic recovery will be anything monumental. Still, several economists we follow expect 3.0% economic growth throughout 2002.
